Broker Check

UFG Market Review

| May 01, 2024

The following graphs reveal one of the concerning aspects of the market rebound that began in October 2022. 

The top section shows the recovery from the Housing market bust in 2008 and the recovery from the Pandemic in 2022.  The bottom graph is the current market.  The common aspect of the top graphs is that all three lines are moving in tandem.  All parts of the markets are participating in gains, which is not the case today.

he stock market has been favoring larger, more stable companies over others.  These companies are less affected by increases in interest rates because they secured low-cost loans for a long time when interest rates were low.  Many of the largest companies, especially those in the tech sector, also have plenty of cash reserves.

Now, let's talk about the green line on the graph, which represents the Russell 2000 Index.  This index consists of smaller-company stocks that are more sensitive to changes in interest rates.  Smaller companies struggle to get loans through bonds and borrow more money at variable interest rates.  Just like when regular people borrow on their credit cards, the cost of this debt has gone up as the Federal Reserve has raised interest rates, hurting the profits of these smaller companies.

Small-cap stocks had a good run at the end of 2023, driven by hopes of interest rate cuts in 2024.  But as inflation stayed elevated, the likelihood of those rate cuts decreased, and small-cap stocks suffered. This makes sense because every day, more low-cost government and corporate debt is getting closer to needing refinancing.

As interest rates stay high for a longer period, more businesses are finding it tough to decide how to refinance their debts as their deadlines approach.  Some are delaying the decision, hoping that rates will drop.  However, the market is already starting to identify companies that need funding within the next 1-2 years and is reacting accordingly.

Likewise, home sellers are putting their properties on the market because they need to move, even if it means losing out on their low mortgage rates.  For instance, empty-nesters may need to find homes without stairs and with walk-in showers.  Meanwhile, growing families who have outgrown their starter homes must find new places to live.

As I write, the stock market is rallying because it heard the head of the Federal Reserve tell us he doesn't expect that they will have to raise interest rates.  The part of the speech about rates staying high until inflation comes down didn't seem to register.  I still believe the stock market will have difficulty moving decisively higher without confidence that inflation and interest rates are coming down.