Markets approaching an 'ugly seasonal period' amid rate cuts

The Federal Reserve is anticipated to cut interest rates in September following Fed Chair Jerome Powell's dovish comments in his Jackson Hole speech last week. However, Wall Street is now considering the impact of rate cuts as markets (^DJI, ^IXIC, ^GSPC) begin pricing them in.

FS Investments chief market strategist Troy Gayeski joins Catalysts to discuss rate cut outlooks and sheds light on his market perspective.

Gayeski notes that while markets are recovering after early August corrections, equities are entering "a pretty ugly seasonal period historically." He also notes that current market valuations are exceptionally high, advising investors to "focus on growth at a reasonable price."

Regarding the anticipated Federal Reserve rate cuts, Gayeski states, "This is one of the few times where markets are actually aligned with reality." He predicts three cuts before the end of 2024, with an additional three to six cuts in 2025, suggesting this could help stave off a recession.

However, Gayeski cautions, "If the Fed ends up cutting more aggressively, that basically lays out the scenario you're discussing, where we are going to enter an unexpected recession. And that point, clearly, equities will go through a meaningful dislocation."

For more expert insight and the latest market action, click here to watch this full episode of Catalysts.

This post was written by Angel Smith

Video Transcript

We're seeing all three major averages right now slipping about 30 minutes into trading on the back of this stronger than expected Consumer Confidence report.

We did see just a little bit more movement here, but this is largely where we've been at over the course of the start of today's trading activity.

Markets have recovered from the early August slump.

Yeah, you remember that my goodness, mercury went into retrograde and the markets reacted and the S and P 500 trading near highs, the dow closing at an all time high on Monday.

So is there more room to run in this rally in this rebound that we've seen or should investors seek less risky opportunities?

We've got Troy Gaki who is the chief market strategist over at FS Investments.

Troy, always a pleasure to speak with you and get some insights here.

So do you believe that there is more room to this rally?

Yeah, I think in the ultra short term, we're continuing the recovery phase from the recent correction which was driven by obviously tremendous and strength and deleveraging uh across markets.

However, we're going into a pretty ugly seasonal period historically in September and you know, valuations are a terrible indicator of short term performance, but they tend to be a pretty good indicator of medium to long term performance.

And we're back, we were through yesterday.

Uh it's open 21.5 times forward earnings, which is more expensive than we came into uh 2022 before the fed started to tighten.

So, you know, for our clients, we're really focused on what we refer to as growth at a reasonable price.

Kind of an almost archaic concept for public listed equity markets these days in middle market, private equity, particularly focused on the secondary market market where there's a lot of selling pressure still from institutions, you can pick up pretty good discounts.

And then if you're trying to get income, you know, there's still tremendous opportunities in private credit because even though the fed is about to cut, you know, the new terminal rate is three, the current base rate is five and a quarter and you're still earning a healthy spread to risk free with deleverage balance sheets and tremendous opportunity in asset based lending Troy.

Just to circle back on the set of it, all that you mentioned here that the level of cuts that the market is pricing in right now feels commensurate with a economic downturn, right?

And, and I'm curious, can you have your cake and eat it too?

Can you anticipate 100 basis points of cuts before the end of this year and also be pricing in an equity market that's going to continue to hit new all time highs.

Yeah.

So we're, we're have been coming into this year.

We were in the 2 to 3 cut camp.

We're now at three, we'll more than likely get 325 base points cut.

So the markets price in a little bit more than it'll probably take, uh, place.

Um, that being said, if you think of this entire fed hiking and cutting cycle, this is one of the few times where markets are relatively aligned with reality.

Remember coming into the year, there was the uh prospect of six cuts, which was laughable.

And then when we got stronger inflation data in Q two, it was like the fed's not gonna cut it all.

That was laughable.

Um Y your point is accurate though.

It's tough for the fed to thread the needle.

But remember we're in a period now where, you know, business fixed investment is cranking construction spending is still going strong.

Uh The consumer is not in the robust shape.

They were a year ago but is still in a relatively good place.

And, and so our expectations for the fed to guide uh or cut by three times next year, somewhere between three and six that should help support consumption and keep us out of recession.

However, if the fed ends up cutting more aggressively, that basically lays out the scenario you're discussing where we're we are gonna enter an unexpected recession.

And at that point, clearly equities will go through a meaningful dislocation, you know, think somewhere around 20 twoish type price action or slightly worse.

But that is certainly not our base case.