What to be thinking about with the Fed on the brink of cutting rates…
Breakwater Team • August 20, 2024
We have all heard the adage… “Don’t fight the Fed.” That was sage advice back in 2022 as the Fed embarked on the most aggressive tightening cycle dating back 40 years. That year both stocks and bonds withered, ending the year down by double digits, you would have to go back to 1941 the last time both asset classes showed losses for the year when you use the 10-year Treasury as a proxy for the bond market. Now with the pendulum shifting from tightening monetary policy to “easier money” everyone is trying to understand what that means for the economy and their portfolio in the months and years ahead. Lately the narrative has shifted a bit, there is a growing chorus that believes that monetary policy and by that we are really referring to the Fed’s setting of overnight interest rates in an economy dominated by bits and bites versus the more tangible attributes of yesteryear has less impact today. Or perhaps, it’s those long and variable lags Milton Friedman was referring to as higher rates are still making their way through the economy. If that is the case it stands to reason that even if liftoff is September it may take time for lower rates to exert their influence. In this piece we are going to explore rates from a few different perspectives. One thing to make clear, we are not market timers and market rates are a byproduct of not just Fed policy, but numerous other factors, like growth and inflation expectations, fiscal policy, the state of geopolitics etc… We can use the past as a prologue have been taking and will continue to take some steps on behalf of our clients whose assets we are managing for important life goals.
Equity Investing
U.S. Stocks
When the Federal Reserve cuts interest rates, it typically has a positive impact on US stock markets. If that is to play out again now, making sure that your portfolio is allocated properly when the Fed is inclined to cut rates is critically important. Here are some key points on how and why this occurs:
- Lower Borrowing Costs: Reduced interest rates make borrowing cheaper for companies and consumers. Newly lowered rates can lead to increased spending and investment, which often boosts corporate profits and, consequently, stock prices.
- Increased Consumer Spending: With lower interest rates, consumers may be more prone to take out loans for big-ticket items like houses and cars. Increased consumer spending can drive higher sales and earnings for companies, positively affecting their stock prices.
- Improved Corporate Earnings: Companies with existing debt benefit from lower interest payments, which can improve their profitability. This can lead to higher stock valuations.
- Shift from Bonds to Stocks: Lower interest rates typically lead to lower yields on bonds. Investors seeking higher returns might move their investments from bonds to stocks, positively impacting stock prices.
- Economic Confidence: A rate cut is often seen as a proactive move by the Fed in support of the economy. This can boost investor confidence, leading to increased buying activity in the stock market.
- Sector-Specific Impacts: Certain sectors, such as technology and consumer discretionary, often benefit more from lower interest rates due to their reliance on borrowing for growth and consumer spending patterns. Sectors that are highly capital intensive or with significant fixed costs stand to benefit more than asset light business historically. Financials tend to see their net interest margins or “NIM” shrink as rates come down, though a protracted period with an inverted yield curve may be less make lower rates less of a headwind if the curve returns to its normal sloping relationship where longer rates are higher than shorter rates. Manufacturers could see a benefit if lower rates mean a lower dollar making their goods more competitive when it comes to global trade.
Small Cap Stocks
With the incredible rise of the Magnificent 7 stocks, small cap stocks have been overlooked. A change in outlook by the Fed may create an environment for small cap stocks to continue to climb.
- Lower Borrowing Costs: Small-cap companies, which often have higher debt ratios than larger companies, benefit considerably from reduced interest expenses when rates are cut. Lower borrowing costs can improve their profitability and support expansion efforts whether it be adding to their workforce or expanding research & development.
- Growth Potential: Small-cap stocks are typically seen as growth-oriented investments. Afterall, companies that are now among the largest companies in the world like Amazon, Apple, Nvidia and Microsoft all started as small caps! Lower interest rates can spur economic activity, benefiting smaller companies that may be more agile and able to capitalize on new opportunities.
- Increased Risk Appetite: Rate cuts can increase investor confidence and risk appetite. Investors may be more willing to invest in higher-risk, higher-reward small-cap stocks during periods of lower interest rates.
- Access to Capital: Lower interest rates can make it easier and cheaper for small companies to raise capital, whether through loans or equity offerings. This can help them invest in growth initiatives, leading to higher stock prices.
Overseas Equities
- Yield differentials may narrow: Foreign capital has been lured into US assets for many years dating back to the European Debt Crisis in the early 2010s. If US interest rates look less attractive by comparison than foreign capital may be onshored and find its way into local stock markets.
- A weaker dollar may ease inflation and lower borrowing costs: A more common phenomenon in the emerging markets where consumption of commodities represent larger percentages of overall spending may allow for capital to be directed more productively and as foreign companies and countries often offer dollar bonds to institutional investors to hedge the currency risk the cost of that interest could drop if the local currency strengthens vs. the dollar.
- Foreign assets may offer a store of value: Should the dollar weaken, it stands to reason that it’s losing ground to some other currency; that relationship can serve as a hedge to offset the diminishing purchasing power of local assets.
After a long run with a stronger dollar, if there is a secular shift underway that will unfold over the years ahead, having some additional exposure aboard would be valuable from both a risk and return perspective. The combination of more attractive valuations should provide a little extra incentive to increase the ex-US holdings in the portfolio, even if it is just at the margins. One thing to keep in mind, in the past monetary policy has generally been pretty well coordinated, but if that is to change in the years ahead it will be that much more important to have some professional oversight to help navigate what could result in a little more short-term volatility.
Stocks historically have fared well when the easing cycle begins, though it’s not always the case, especially if the easing is in response to a shock to the economy or deteriorating fundamentals. The latter does not appear to be the case today though there are signs of continued cooling in the labor markets where with the former, a shock, well, that’s tough to predict, after all it wouldn’t be considered a shock. It’s those known unknowns or unknown unknowns, that get you in trouble to quote the late Donald Rumsfeld.
Fixed Income Investing
When the Federal Reserve starts to alter its posture regarding rates, it creates an opportunity to make adjustments to the fixed income portion of your portfolio. Investment-Grade Corporate Bonds have traditionally outperformed short-term bonds when the Fed ends a cycle where it was increasing rates. Here are a few reasons why corporate bonds might make sense.
- Lower Yield on New Bonds: When interest rates fall, newly issued bonds typically offer lower yields. Existing investment-grade corporate bonds, which have higher yields, become more attractive in comparison, driving up their prices.
- Lower Borrowing Costs: Companies issuing investment-grade bonds can refinance existing debt at lower rates, reducing their interest expenses and improving their creditworthiness. This increased financial stability can lead to higher bond prices.
- Increased Demand for Yield: In a low-interest-rate environment, investors seeking higher returns may shift from government bonds to higher-yielding investment-grade corporate bonds. This increased demand can push up bond prices.
- Reduced Default Risk Perception: Lower interest rates can stimulate economic growth, improving the overall business environment. This can reduce the perceived risk of default among investment-grade issuers, making their bonds more attractive.
- Relative Safety: Investment-grade bonds are considered safer than high-yield (junk) bonds. In a low-rate environment, investors may prefer the relative safety of investment-grade bonds while still seeking higher returns than those offered by government securities.
Treasuries
- Price and Yield Inverse Relationship: Bond prices and yields move inversely. When the Federal Reserve cuts interest rates, the yields on newly issued Treasuries fall. As a result, the prices of existing Treasuries with higher yields rise, making them more valuable to investors.
- Increased Demand for Safe Assets: In a low-interest-rate environment, investors often seek safe-haven assets. US Treasuries are considered some of the safest investments in the world due to their backing by the US government. This increased demand drives up their prices.
- Portfolio Rebalancing: Institutional investors, such as pension funds and insurance companies, may rebalance their portfolios to maintain a desired mix of assets. Lower interest rates can lead these investors to increase their holdings of Treasuries, further driving up prices.
- Expectations of Further Rate Cuts: When the Fed cuts rates, it may signal the potential for future cuts, especially if the economic outlook remains uncertain. This can lead to increased buying of Treasuries as investors anticipate further price appreciation.
- Economic Uncertainty: Rate cuts are often implemented to support the economy during periods of uncertainty or slowdown. During such times, the demand for risk-free assets like US Treasuries increases, boosting their prices.
- Flight to Quality: In times of economic stress or financial market volatility, investors often seek the safety of US Treasuries. Even if the rate cuts are meant to stimulate growth, the initial reaction can include a flight to quality, supporting Treasury prices.
CDs
When the Federal Reserve starts to cut rates, usually that will most impact the short end of the yield curve. For the past few years 5% on the short end of the yield curve was commonplace. These rates have already started to creep down and will likely drop further, even just in anticipation of the coming rate cuts. So, for all those CD lovers out there, if you stay on the short end where banks may still be offering specials that are close to the 5% range. If you wait, it may be a while before we see 5% again.
Loan Refinancing
Home Mortgages
If you are among the blessed mortgage holders that either bought a property or were savvy enough to refinance when rates went down below 3%, skip this paragraph. You aren’t going anywhere for another 20+ years it would seem. For those of you planning to buy a primary, vacation or investment property, rates have already started to fall in anticipation of the Fed cutting rates. If we see multiple rate cuts for those that bought a home in the last two years, this may present an opportunity to refinance with the goal of lowering your payment while not extending your term by a significant margin.
Student Loans
Student loans can be either Federal loans or private loans through a bank. Private student loans offer the potential opportunity when rates start to fall. Student loans, like many other consumer loans, are eligible to be refinanced. The typical private student loan is a 10–20-year payback term reducing the interest rate can have an impact. It is worth noting that if you choose to refinance and the term is extended, you should be able to lower your payment but, it is important to keep in mind how much additional interest will be paid over the life of the loan. Federal loans are treated differently, they can be consolidated (versus refinanced) whereby multiple loans are being combined to fewer loans and an average of the interest rates on the original loans are then applied.
In closing, we are about to embark on a new phase and with that will come the necessary adjustments, on balance lower rates are more likely a good thing than a bad thing, after all interest is the cost of money. We will monitor the possibility that lower rates have a bit of a self-fulfilling effect whereby consumers and companies see that rates are in fact really coming down, not just being talked about. The risk is that, with the idea of holding out hope for even lower rates by delaying purchases and investment, the softening of demand results in further cooling and labor softening. Many have speculated that one of the reasons for the slow recovery after the financial crisis, aside from the scars that period ushered in, was the lack of urgency on the part of consumers and corporations alike as rates where likely to be lower for longer in the new zero interest rate period or “ZIRP” regime.
The views expressed represent the opinions of Breakwater Capital Group as of the date noted and are subject to change. These views are not intended as a forecast, a guarantee of future results, investment recommendation, or an offer to buy or sell any securities. The information provided is of a general nature and should not be construed as investment advice or to provide any investment, tax, financial or legal advice or service to any person. The information contained has been compiled from sources deemed reliable, yet accuracy is not guaranteed.
Additional information, including management fees and expenses, is provided on our Form ADV Part 2, available upon request or at the SEC’s Investment Adviser Public Disclosure website, www.adviserinfo.sec.gov. Past performance is not a guarantee of future results.
Breakwater Team
At Breakwater Capital, we work with families across the United States, providing each client with a personalized experience tailored to their current circumstances, future goals, and timelines.
It’s annual enrollment time and for those with a small business or buying health insurance privately or in your state’s marketplace, it’s a wonderful time to revisit whether or not a Health Savings Account is right for you. While many of us are acutely aware of the rising healthcare costs, according to a recent WSJ article the data suggests with an aging (and somewhat unhealthy) population it’s hard to see any relief on the horizon. So, what can you do aside from eating well, exercising and managing stress to limit your trips to the physician’s office and minimize how much money you spend on healthcare each year. Here is something worth considering. First, let’s define a Health Savings Account (HSA). It is a tax-advantaged savings account designed to help individuals and families save for medical expenses whether for the year ahead, or better, for those expenses they’ll incur later in life. The account itself is paired with a high-deductible health plan (HDHP) which generally carry lower plan premiums as the insured (you) accept a little more of the financial responsibility for visits/treatments than traditional insurance. Here's how an HSA works and some key features:
Some financial pundits suggest that all you need for financial success is a “set it and forget it” approach with passive index fund investing. While long-term investing is indeed advantageous, is that truly all you need to do? What about tax-saving strategies, generating retirement income, or establishing a solid estate plan? And how should you respond to major life changes or significant market volatility? The simple fact is that managing wealth is complex, especially for high-net-worth individuals. From investment choices to tax planning and business succession, navigating these areas without professional guidance can lead to costly oversights. Partnering with a skilled fiduciary advisor can simplify the process, helping you focus on long-term success while steering clear of potential pitfalls. Breakwater Capital Group provides advanced wealth management solutions rooted in integrity and transparency. Our team of fee-only fiduciary advisors brings clarity and strategic insight to clients across the country. This article explores the benefits of professional wealth management advice, highlighting the value of a fiduciary advisor who provides comprehensive and personalized financial solutions.
Spring is a time for renewal—a season to declutter, reorganize, and bring fresh energy into our lives. While cleaning out closets and tidying up your home, why not do the same for your finances? A cluttered financial situation can lead to stress, missed opportunities, and hidden costs that can throw off your long-term plans. Taking the time to organize your finances can help you feel more in control and ready for the future. With over five decades of combined experience, Breakwater Capital Group helps clients nationwide manage their assets, offering personalized guidance through our Massachusetts, New Jersey, and Colorado wealth management offices. In this blog, we’ll explore why financial organization matters and the key steps you can take to refresh your financial life this spring.
Imagine you’re preparing for your retirement, anticipating enjoying the fruits of your labor. Then, you notice interest rates changing and fret about its impact on your savings and investments. Understanding these changes is crucial for maintaining the health of your finances. Monitoring trends in the economy enables you to make smart choices and navigate transitions wisely. Rising and falling interest rates can impact several aspects of planning for your retirement, such as investment performance and the cost of borrowing.
…grant me the serenity to accept the things I cannot change, the courage to change the things I can, and the wisdom to know the difference. – Reinhold Niebuhr In a year that had already witnessed a noticeable uptick in volatility compared to the prior two years, the ongoing back and forth regarding looming tariffs, culminated in what has been described by many pundits as some of the most aggressive levies introduced since the 1890s. While the policy announcements themselves have been well telegraphed, the scope and scale are considerably higher than what was expected, as evidenced by the market’s harsh response. Rather than imposing tariffs based on pre-existing trade protections with our counterparties (i.e., existing tariffs, subsidies, or other barriers to entry) the formula to arrive at the tariffs focused more on the trade imbalance between the two nations. As the largest economy in the world, trading with nearly everyone, many of which are much smaller countries/economies, this was ripe for distortion. For those who have been long time followers of President Trump’s beliefs this should come as little surprise, a recent piece in the WSJ captures quotes dating back to the 1980s which share his perspective that the US was drawing the short straw and other nations should have to pay to access our robust and dynamic economy. Going back to the days of the earliest trade when men roamed the earth hunting for food there has always been some degree of mercantilism whereby one group looks to accumulate power and wealth and protect their own interests, but in the Post World War II era, it’s inarguable that the US has benefited enormously from their embrace of “free trade” and capitalism. Our economy has grown a hundredfold since 1950 when it was approximately $270BB. The naysayers will point out that back then the US accounted for about 50% of global GDP, peak wealth, or about twice what it is today, but that fails to account for the fact that much of the world having fought the theatres of war in both Europe and the Pacific was in ruin and needing to be rebuilt. There is a misconception that both NAFTA (1994) and China’s entry into the World Trade Organization (2001) were the watershed moments leading to the hollowing out of the US’s manufacturing base, but in reality manufacturing employment had been in decline going back to 1950. At its peak US manufacturing workers accounted for about 30-35% of the nonfarm workforce, whereas today that level sits at around 8% where it has hovered for the last 15 years. In 2000 it was just 15% so still very much the minority. This long-term shift in the mix of the US economy where services now account for a disproportionate percentage of GDP and the workforce overall is the result of a far more skilled workforce driving both innovation and productivity. Surely some manufacturing jobs have left based on the focus on corporate profits, but some of the change relates to comparative advantage and inexpensive labor. It’s not to say, that we should look to push all manufacturing to the most “efficient” destination, surely it’s important to maintain control of manufacturing of critical components to defense, information technology or medicine, but it seems unrealistic at best to expect that we can produce enough and at reasonable costs to satisfy our insatiable demand. We are after all only about 5% of the world’s population, though we account for 25% of global GDP. Talk about punching above our weight. Aside from the logistical challenges that reshoring/onshoring pose, not to mention the timeline associated with the payback for such efforts, the willingness or lack thereof on the part of the business and consumers alike beg the question of whether or not it is worth pursuing. Considering our societal tendencies for policy to reverse course every 4-8 years with Washington’s constant changing of the guard which has grown even more partisan in recent years, it’s hard to envision the private sector making these investments where there may be little or no long-term benefit to the majority of stakeholders, mainly consumers and shareholders alike. If we are being intellectually honest, as we have seen with the likes of Amazon, if automation or robotics can do the work better than human beings, who need benefits and breaks, the case for this policy bolstering manufacturing employment seems weak at best. That’s one of the key pillars of the artificial bull case after all. In addition, there is clear evidence that economies which produce a disproportionate amount of goods versus services are much more susceptible to the boom bust cycle as demand for goods themselves is far more cyclical, look no further than Japan and Germany whose export driven economies have largely languished for the last 20 years in the slow growth/no growth period in the aftermath of the Great Financial Crisis. Let’s put all this into context, according to the World Trade Organization as of 2023 the US had a trade weighted tariff rate of 2.2% lower than nearly all countries around the world. For a country that is such a massive importer one might argue the low levels fostered healthy trade relations with some of our key allies and admittedly some frenemies or altogether poor bedfellows. With these sweeping tariffs, some as high as 49%, this marked a significant shift in policy where the aforementioned tariff rates will approach 30%, having a significant and lasting impact on consumers and businesses alike. Whether you want to describe a tariff as something different than a tax seems to be semantics, the added expense is rarely fully eaten by the producer. In the aftermath of the pandemic and the correspondingly high inflation due to excessive fiscal and monetary policy along with supply side disruptions, its doesn’t require too much detective work to know the average American is exhausted or outraged by higher prices. The tariffs will only add to the price at the register unless we all of a sudden find the private sector extraordinarily benevolent, willing for much if not all of the added costs to result in shrinking margins. By now you have surely figured out why there was such a market kerfuffle, but let’s make sure to fully examine why the result was to shave $3 trillion of market value off of US stocks in one day, which supposedly is the equivalent of 5 years’ worth of tariff receipts. First and foremost, despite opening the year with an economy bumping along with real GDP around 2.50% we have seen a sharp decline in the soft data, where surveys from the confidence board and University of Michigan plumb levels we have not seen going back to the pandemic when fears of a severe respiratory infection and 10% unemployment were front of mind. The hard data has been only a little better as labor has held up thus far, but as we have seen in Retails Sales there are signs that the consumer may be tapped out or growing wearier. With GDP likely to be between negative .5% to positive .50% for Q’1 that it’s like slamming on the brakes while driving in the passing lane. No surprise that there may be a real sense of whiplash. As the odds of a recession have risen, something the President himself acknowledges, it’s safe to assume expectations for earnings growth this year and next seem to be slipping away. With valuations stretched, there has been little margin for error and it’s those stocks, some of the most expensive that have felt the impact that much more acutely. This is why we have heard the “Mag 7” referred to as the “Lag 7” here in early 2025. Now you might be thinking this is likely transitory, a word that is making its rounds again after an ill-feted debut to Wall Street vernacular in 2022. If we are in fact, we are likely to see a shift to a more capital-intensive economy, is it reasonable to justify such high multiples which made more sense in an asset light, intangible heavy ecosystem? It seems hard to justify, from this vantage point. Hopefully, we will avert a recession, but that’s not to say it is an all-clear sign for the stock market. Earnings recessions, like that of 2022, may not lead to large scale job losses and disinflation, but increase the prospects for a bear market. There is a risk here that those fat margins whither because of trade frictions and lead to something more pernicious like a repeat of the stagflation episode of the 1970s and early 1980s where higher inflation sucks the oxygen out of the room leaving little room for real growth. So, what is an investor to do… Well for one thing, maintaining discipline in the form of diversification has helped and likely will continue to, with investors who have roughly half of their portfolio in overseas stocks and fixed income, the positive returns in these two areas have been able to offset some of the decline in US stocks. Incorporating other assets like Treasury Inflation Protected Securities (TIPs), gold or real estate may help mitigate the risk somewhat but as we have seen in the past times of market angst correlations often increase, giving the appearance there is no place to hide. Eventually markets will calm down, as the last of the sellers capitulate, though that process can take weeks or even months to play out. I’ll leave you with some quotes from some of the smartest minds on Wall Street to ponder as we head into the weekend. “Sometimes the share price of a firm tells the CEO of that firm nothing about their company they didn’t already know. Other times, the stock market takes on the role of “active informant.” Stock prices predict investment because they provide business managers with useful information about the future. I think now is probably one of those times. -Neil Dutta, Head of Economics, Renaissance Macro “We all know the math: the stock market has historically grown by 10-11% over the long run but only gone up 60-70% of the time. That means it has corrected 30-40% of the time. Surviving those drawdowns is the price of admission.” -Jurrien Timmer, Director of Global Macro at Fidelity Investments “We are a great nation, the leader of the free world. Yet we squander our political power to appease the textile industry in the Carolinas! We should instead be setting a standard or the world by practicing freedom of competition, of trade, and of enterprise that we preach. -Milton Freidman This presentation is not an offer or a solicitation to buy or sell securities. The information contained in this presentation has been compiled from third-party sources and is believed to be reliable; however, its accuracy is not guaranteed and should not be relied upon in any way whatsoever. This presentation may not be construed as investment, tax or legal advice and does not give investment recommendations. Any opinion included in this report constitutes our judgment as of the date of this report and is subject to change without notice. Additional information, including management fees and expenses, is provided on our Form ADV Part 2 available upon request or at the SEC’s Investment Adviser Public Disclosure website, www.adviserinfo.sec.gov. Past performance is not a guarantee of future results.
If you’re a business owner, you’ve undoubtedly spent years building your company and made countless sacrifices. Have you considered how your business will transition to new leadership when you’re ready to step aside and pursue other goals? A succession plan can help preserve the value you’ve worked hard to build. Succession planning is not just about who takes over but how the transition happens to ensure the business’s long-term survival. Whether passing ownership to family, employees, or external buyers, it’s wise to have a strategic plan that minimizes disruption and protects your company’s value. At Breakwater Capital Group , we help business owners develop comprehensive succession plans. With decades of experience, Breakwater is a fee-only fiduciary financial advisory firm serving clients nationwide with wealth management offices in Denver, CO, Paramus, NJ, and Greater Boston, MA. This blog explains why having a succession plan is important, outlines its key components, and shows how Breakwater can assist you in this crucial process.
Watching the news and seeing sudden drops in stock prices or economic events that threaten your wealth is stressful. Market volatility is becoming more common in today’s fast-paced and interconnected world. However, depending on how you’re invested and what your financial situation is, a volatile market doesn’t automatically spell trouble. At Breakwater Capital Group , we navigate economic uncertainty with personalized financial planning and investment strategies. As a fee-only fiduciary financial advisory firm, we proudly serve clients nationwide, with wealth management offices in Denver, CO, Paramus, NJ, and Greater Boston, MA. In this blog, we’ll explore what market volatility is, how to be mindful of it, and the strategies Breakwater uses to help clients manage it effectively.
Every parent wants to give their child the best opportunities in life, and a quality education is a key part of that. However, with college costs rising rapidly, planning ahead has never been more important. Over the past 20 years, tuition and fees at public four-year institutions have more than doubled, making it essential for families to explore various options and develop a savings strategy. At Breakwater Capital Group , our Greater Boston based wealth management team works with individuals and families nationwide to develop financial plans that incorporate college savings while keeping other financial priorities on track. This guide discusses the rising cost of college, available financial aid, and practical strategies to help Greater Boston parents prepare.
Where do we go from here… It would be understandable if you thought the market has already experienced a correction here in the first two months of 2025. It was just last week however that the market touched all-time highs, but over the last week the Standard & Poor’s 500 Index has traded down by about 4.2% with many popular stocks (Tesla, Palantir & Nvidia to name a few) down multiples of that amount. Concerns about a slowing US economy based on softening recent data and a torrent of policy announcements have contributed to the weight on the tape. It may turn out that this was the start of something more substantial or a healthy flush out of the excess enthusiasm ushered in after November’s election. Time will tell. Let’s take a short walk down memory lane to frame where we stand presently. After a brutal 2022 that saw double digit declines for both stocks and bonds, keep in mind only two other times in history have we seen simultaneous negative calendar year returns for both stocks and bonds (1939 & 1961), the combination of cooling inflation and more attractive valuations for both asset classes kicked off strong rally in the 4th quarter that year. Aside from a correction that started in the summer of 2023 that wrapped up around Halloween, the market has been on a tear, with only a few pockets of volatility flaring up along the way. Market concentration has been a factor with a significant source of the overall returns coming from a handful of stocks, though it is safe to say that the rising tide lifted most ships in that time. Heading into 2025, following back-to-back 20% return years, valuations hovered at 22 times forward earnings, more than 20% above their 30-year average and nearly 38% pricier than the p/e ratio over the last 95 years. A return to earnings growth was a welcome driver of higher stock prices, though truthfully much of the increase in the 2+ years since the bear market trough has come from multiple expansion. What makes that particularly interesting is that this is in spite of higher interest rates, where there attractive sources of alternative return would typically be a net negative for equities. Let’s be clear, higher valuations do not necessarily need to reset back to historical levels though that’s entirely possible. It is reasonable, however, to assume richer prices will impact future returns and leave little margin for disappointment when it comes to the data, whether we are speaking about the macroeconomic backdrop or idiosyncratic factors impacting individual companies. All this is meant to suggest the merits of diversification, which can and should be used as a tool to both possibly augment returns or reduce portfolio volatility. The early indications here in 2025 are illustrating those benefits. The MSCI EAFE index, the S&P equivalent for the developed markets outside the US, is up nearly 8%, perhaps finally looking to close a wide performance chasm that occurred over the last 15+ years. Similarly, bonds have offered a port in the storm, as the Bloomberg US Aggregate Bond Index is up about 2.50% year to date. More on the topic of bonds… As we spend the early part of the year commiserating about the news of premium hikes for our health, auto or homeowners’ policies it is not uncommon for us to question the value of those policies, especially when year after year we go without filing a claim. Insurance has been resigned to being a necessary cost to avoid a financial catastrophe in the face of some adverse event, but I am not sure it is appropriate to share the same perspective about portfolio insurance. There are a variety of ways to protect one’s portfolio from raising cash, to using structured products or derivatives, but as the saying goes the only free lunch in investing is achieved through diversification. 60+ days into 2025 spreading out your bets is paying off with the vaunted Magnificent 7 down about 8% while many other areas are positive if not materially positive in that time. Sure, we have seen a number of head fakes over the last 4-5 years where the luster was seeming to wear off only to see these hyper-scalers find their footing and catch investor’s fancy, but all good things must come to an end eventually. Whether or not that’s 2025 or at some point in the future, we’ll need to wait and see, but do not expect me to keep wagering on a handful of expensive stocks alone. The capital markets are vast and deep, odds are when we reflect back in 5-10 years the top performing assets likely will surprise us. With a 5-year annualized return of -.62% for the Bloomberg US Agg, it is understandable why investors may be disinterested in this asset class. Stocks on the other hand, as measured by the S&P 500, have averaged 15.15% over the same period, that’s a nearly 80% difference and if history was to consistently repeat itself it would be fair to ask yourself what’s the point in owning bonds. However much like car insurance or homeowners’ insurance they are there to provide some real value (protection) should something calamitous happen to the stock market. What’s unique here is that typically insurance, comes at a cost, in the form of a premium, but with bonds you actually get paid (interest) while you are holding them and the real downside is opportunity cost or foregone returns, which seems a lot better than a premium payment for a claim never filed or a 20% bear market for that matter. Back to the present, in the aftermath of the 2024 election, markets reflected an optimistic tone regarding President Trump’s return to the oval office. The thinking mainly focused on a pro-growth agenda where regulatory relief and further tax reform would support asset prices. While questions remained about the impact of tariffs and immigration policies, the administration was given the benefit of the doubt that any approach would be measured and hopefully well telegraphed. Now roughly 40 days into his second term, the President has issued innumerable executive orders, some of which will be challenged in court while the impact of others still needs to be flushed out and the rhetoric on tariffs has been far more bombastic when it comes to historic allies and perhaps less onerous on China where much of the political capital and energy was spent in 2017-2018. On balance, tariffs are a net negative as the costs are born by the importing country, possibly contributing to inflation at a time when there is little appetite for higher prices. A country that historically espoused the merits of free trade would be best served to limit tit for tat trade policy and instead source goods from nations that have been more aligned with our interests. In the end I am hopeful this ends up being about negotiating leverage rather than the start of something more painful for consumers and workers who likely would feel the second order effect of waning demand or strained budgets. While perhaps well intentioned, the fact is other countries may very well have ample capacity to ride out any policies that they find detrimental to their own economies. DOGE and the microscope on spending. Over 60 years ago, Lyndon Johnson who campaigned on the notion of the Great Society introduced legislation that created Medicare and Medicaid, the formation of the U.S. Department of Housing and Urban Development and Head Start among others embarking on a journey that would see the government’s role in society expand exponentially. These programs added to the social safety net that was initially created in the aftermath of the Great Depression where Social Security and the Supplemental Nutrition Assistance Program (SNAP) were born. In general, these programs have grown far faster than the rate of inflation, in some instances crowding out the private sector and creating ample opportunities for mismanagement, whether intentional or otherwise. To their credit, both Ronald Reagan and Bill Clinton instituted policy priorities to right size these programs, but other administrations have been willing to grow entitlements with little consideration to demographic dynamics, incentives or the capacity to cover these costs which eat up more and more taxpayer dollars with less and less accountability. The United States with a budget of $7TT, of which $2.8TT is attributed to deficit spending, finds itself with 60%+ dedicated to mandatory spending which is comprised of interest on our debts, some veterans benefits and the aforementioned Medicare and Medicaid programs along with Social Security. Discretionary spending, which makes up the difference, is where you’ll find defense spending as well as outlays for education, transportation, science, foreign aid etc.… We can all agree that any opportunity to eliminate waste or fraud or for programs that have limited benefit to our interests abroad should be heavily scrutinized and eliminated. Assuming a more measured approach around enacting reform should be welcomed and will likely have a positive impact on the economy and the markets in the years ahead. The public seems comfortable with the idea of reviewing expenditures, but the “move fast and break things” approach has been unsettling as witnessed by recent poor readings on consumer sentiment from both the Conference Board and University of Michigan monthly read outs. The irony of the “tough on everyone” approach, including our allies, may result in invigorating economic regions that have been prone to bouts of sclerosis. The Europeans seem particularly rallied around the idea that the United States sense of elitism is misguided which could foster some healthy competition though it could foment some ill will towards Americans and their corporations. The combination of less demanding valuations, more space for fiscal and monetary stimulus along with something resembling animal spirits would go a long way towards creating synchronized global growth which we have seen on a few occasions in the last several decades. Assuming you see something of a détente with China later this year so long as they allow for some modest currency appreciation and fiscal stimulus it could be off to the races for foreign stocks. Lastly, on the topic of interest rates, the real cost of money after all, the next few months will be rather interesting to watch unfold. March offers the February Nonfarm Payroll Report and a Fed meeting with the updated Summary of Economic Projections (SEP) where the possibility exists that they may shift from a slightly more hawkish posture to a more balanced tone, hinting at 3 rate cuts for this year, which would be well received. We are still likely 6-7 rate cuts or 1.375% away from neutral, but far less restrictive than we were just 6 months ago. If rates do head back down in an orderly fashion, it’s hard to envision a scenario where that’s not modestly bullish for risk assets. Away from short-term rates, which are really driven by Central Banks, Treasury Secretary Scott Bessent has been talking about the efforts to bring the 10-year Treasury yield lower. The rate has dropped about .50% since the start of the year though perhaps the fact that it’s been a somewhat rapid decline has served to spook the market somewhat as after all the bond market has been considered the smart money versus the stock market but we won’t get into that today. Since the 10-year rate has more influence on long-term borrowing costs, including mortgage rates, it was welcome to hear that there is extra attention there, though government policy is only one component of the pricing behind that security. If rates remain rangebound this year somewhere between 4-4.50% it bodes well for the economy and markets, rates falling too sharply would likely be the result of a risk of trade perhaps related to an exogenous shock and rates going too high (5%+) would start to put more pressure on equities and high yield bonds. To come full circle, there is a lot going on and perhaps a bit more uncertainty than would be the case with a newly elected administration that controls both chambers of Congress. Until there is further policy clarity and businesses are able to show their ability to grow earnings and improve margins, we would be well served to prepare for more volatility than we experienced in the last couple of years. Over the last 25 years the average intra-year decline for the stock market has been 15.4% so while we will not ask you to enjoy something like that we should be prepared for the possibility. Diversification seems like as good of a tool as any to provide you with a little insurance if there are a few more bumps along the way. Sources: WSJ, Barron’s, AMG, FRED
It may seem like the last 3-4 years have seen a business news cycle dominated by all things interest rates. There is no doubt the “cost of money” is critically important. Rising Interest rates can create both opportunities and risks for your retirement planning. Higher borrowing costs and market volatility may impact portfolio returns and income strategy. Understanding how these changes affect your retirement is key to making informed decisions. At Breakwater Capital Group , we bring over five decades of combined experience managing financial assets for individuals and families with diverse goals, even in shifting economic conditions. We proudly serve clients nationwide through our Massachusetts, New Jersey, and Colorado wealth management offices. This article discusses how changing interest rates influence various investments and outlines actionable strategies to consider for your retirement planning.