Federal Reserve’s hawkish rate cut a signal for investors

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As we head into 2025, we believe there has been a recent development over the past couple of weeks that investors should start paying attention to, especially those aiming to replicate last year’s market results.

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The meeting of the US Federal Open Market Committee (the branch of the Federal Reserve System that sets the direction of monetary policy) on December 18 was a dizzying affair. The 25 basis point rate cut came as expected, but there was some disagreement among members over whether to keep interest rates steady. As a result, the Fed’s plan (the central bank’s forecast of the key short-term interest rate) now expects to cut interest rates by another 50 basis points next year, raising interest rates to 3.9 percent, representing a drop of half the expected rate. Cuts of 100 basis points were previously expected.

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This sudden hardening stance has mostly sent shockwaves through expensive US stock markets, which have been relying on more liquidity coming from the US Federal Reserve to justify current sky-high valuations. Furthermore, we have seen this in some hyper-speculative pockets, such as cryptocurrencies, which appear to be merely leveraged beta strategies, meaning the volatility of their returns is high compared to the broader market. Interestingly, it also had an impact on those companies that benefited from Donald Trump’s victory in the US presidential election, such as MicroStrategy Inc. And Telsa Inc.

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For the majority of professional investors, who are not typically involved in these areas of the market, we are more concerned about the price investors were willing to pay for the large US stocks that were driving the action and dominating the indices.

For example, take one of the largest US companies by market cap, Apple, which recently traded at 41 times its earnings, the highest price-to-earnings (P/E) ratio since 2007 when the first iPhone was launched. Released. This comes despite moderate revenue and profit growth expectations and no major new product launches expected.

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It has now reached the point where the share of stocks with enterprise value to turnover greater than 10 times has increased to levels not seen since the 2021 mania and the 2000 tech bubble.

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The big question is if the Fed gets off half the scale and no longer continues its previous easing pace, how will these companies fill the financial results to support such high multiples?

Jurian Timmer, Fidelity’s global strategist, sums it up perfectly in a recent The P/E ratio is an order of magnitude higher. The five-year cyclically adjusted P/E ratio would be 38.3 times instead of 32.4 times, which is even higher than the peak of the dot bubble. com in 2000. This makes me stop.

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This is something that really deserves more attention and leaves us thinking that perhaps we are returning to a scenario where bad economic news is good news for these companies because it increases the likelihood that the Fed will resume its previous easing path?

Being a market participant before QE was introduced after 2008, this doesn’t really suit us. The markets have become addicted to liquidity, which is unfortunate because it hides some really good companies that are generating some excellent free cash flow that get labeled as “yesterday’s trade” and therefore don’t get the attention they deserve.

Instead, it’s all about borrowing at low interest rates and buying stocks in order to engineer financially enhanced earnings growth. Maybe one day we’ll go back to the good old days of Benjamin Graham and start giving out his famous book, The Intelligent Investor, to read instead of having kids take pictures of him throwing it in the trash.

Until then, we all have to become experts on monetary policy, as our investment portfolios depend on it.

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Martin Pelletier, CFA, is a senior portfolio manager at Wellington-Altus Private Counsel Inc., and serves as an advisor to TriVest Wealth Counsel, an institutional and private client investment firm specializing in risk-managed discretionary portfolios, investment audit/monitoring and advanced taxation And real estate and advanced taxes. Wealth planning. The opinions expressed are not necessarily those of Wellington-Altus.

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