Is the Expansion for Real?

The stock market broadly declined in August. Last month marked the first time stocks lost money since February 2023. The state of interest rates and broader market uncertainty seemed to give stocks a reason to pause. However, the strong stock market returns throughout most of this year appear to indicate that many investors believe stocks represent a great value in the long run.

While the conversation has predominantly focused on stocks, interest rates have steadily increased in the background. Despite these higher rates, few investors seem interested in considering longer-term fixed-income securities as investment options, likely due to the abysmal returns for these types of assets in 2022. Yet, longer-dated bond yields are approaching levels that haven’t existed since before the Great Recession. Perhaps future bond returns have begun healing since current market yields could potentially offer attractive long-term investment opportunities for investors.

Regarding fixed-income investing, many investors are excited about short-term debt, specifically the liquidity it provides and the attractive interest rate it offers in the current environment. As a result, investors may have left long-term bonds for shorter-term fixed-income substitutes and also rotated to stocks to meet their long-term investment objectives. Investors’ general distaste for long-term bonds is likely also fueled by fear over the trillion-dollar deficits ahead and restrictive monetary policies. Neither trend seems dovish for interest rates or bullish for bond prices in the short run, likely causing investors to prefer these substitutes to long-term assets. But, strangely, maybe deficits and higher interest rates represent a unique type of equilibrium in the economy.

Former Vice Chairman of the Federal Reserve, Alan Blinder, wrote extensively on the topic of monetary and fiscal policy. In his analysis, the best decision for the Fed is to maintain a restrictive stance and keep interest rates at a level consistent with or above inflation. In contrast, elected politicians should always vote for budget deficits, choosing expansionary policies over restrictive ones. Therefore, the natural place for economic policy to land, according to Blinder, is with a restrictive Fed and pro-growth government spending. The way Blinder figures this solution out is through the benefits each institution stands to gain by being ahead of the competition. If one of the players steps out of line, power can transfer to the other. Coincidentally, the natural economic landing spot Blinder describes is present in the macro-picture today.

Maybe investors have embraced equities because they recognize the economy may be in an equilibrium state that allows it to grow. Not long ago, NVIDIA Corporation delivered massive financial results, causing its share price to soar and boosting demand for many other technology names competing in a similar space. NVIDIA’s success was structurally driven by increased demand for its popular graphic processing chips that run autonomous and artificial technologies in data storage centers. NVIDIA’s newfound success and increased profit margins will most likely attract the attention of many competitors looking to take market share away from the company. History has many examples illustrating how above-average profits and growth don’t typically last forever. Eventually, competition steps in to get a slice of the pie.

But maybe NVIDIA’s success and, more importantly, the broader stock market represents something more than just stories for investors to chat about. The success of stocks representing a particular sector or single industry might send a particular message that the economy is growing. Typically, stock market returns act as a leading indicator. Therefore, the strong equity market returns since the beginning of the year may indicate that the economy is quite strong, despite the risks and uncertainty that exist. Risk and uncertainty are often manipulated and can unfortunately lead investors to make harmful investing decisions. That’s probably why the late Jack Bogle observed, “The idea that a bell rings to signal when investors should get into or out of the market is simply not credible.”

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