Investment Fireworks Ahead?

If inflation continues to ease and the job market shows signs of cooling, it’s likely that the Federal Reserve will initiate interest rate cuts by the end of 2024. Such a move would light up the equity and bond markets like a July 4 fireworks show.

This Friday’s release of the U.S. nonfarm payroll report for June is eagerly anticipated. Analysts predict an increase of 190,000 jobs, a decrease from the 272,000 added in May. The unemployment rate is expected to hold steady at 4.0%, with a slight uptick in the labor-force participation rate from 62.5% to 62.6%.

Average hourly earnings are projected to cool from a 4.1% year-over-year increase to 3.9%. These labor market trends are crucial indicators of consumer spending and inflation in the service sector.

Current signs suggest the labor market is decelerating, with an increased supply of workers and softening demand for labor. If this gradual slowdown continues without a sharp downturn, it could lead to reduced consumption and lower inflation, providing the Fed with the confidence to start reducing rates.

The Fed’s next meeting on July 31 is expected to result in policy rates remaining at the current level of 5.25% – 5.50%, as gauged by the CME FedWatch Tool (see chart).

However, Wall Street is betting that there could be two rate cuts in 2024, likely at the September and December meetings. This scenario seems plausible if inflation continues to trend towards the Fed’s 2.0% target

The moderation of inflation, especially in shelter and rent costs, combined with a cooling labor market and slower wage growth, supports this outlook. The Fed might opt for a quarterly rate cut strategy to provide stability and reduce market volatility, gradually moving rates to a neutral level over the next several quarters.

Valuation Concerns

Despite these positive developments, there are growing concerns that the stock market is overvalued. Current stock prices appear inflated relative to fundamental economic indicators, such as corporate earnings, economic growth, and interest rates. High valuation multiples, such as the price-to-earnings ratio, suggest that investor expectations might be overly optimistic.

This disconnect could lead to heightened volatility, especially if economic data does not meet these lofty expectations or if the anticipated rate cuts by the Fed do not materialize. Investors should be cautious and consider the potential for a market correction.

While market timing is notoriously difficult, there are prudent steps you can take to protect your portfolio from the potential downside.

Diversification is the cornerstone of risk management. By spreading investments across various asset classes, sectors, and geographies, you can reduce your exposure to any single investment’s poor performance. In the coming months, I expect the laggards of 2023 to become the leaders of 2024 and beyond. Now’s the time to rebalance your assets.

Certain sectors tend to be more resilient during market selloffs and downturns. As the second half of 2024 gets underway, these defensive sectors are poised to outperform:

Utilities provide essential services, leading to steady demand regardless of economic conditions.

Consumer staples include everyday goods like food and personal care products, which people continue to buy in all economic climates.

Health care benefits from consistent demand as health care needs persist regardless of market cycles.

Alternative assets such as real estate, commodities, and precious metals can provide diversification benefits and reduce overall portfolio volatility…which brings me to the investment alternative of marijuana. That’s right…marijuana.

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This article previously appeared on Investing Daily.