Summary, Last Quarter:
In the third quarter, the Federal Reserve cut interest rates by 0.25%—a move that stirred some debate. Tariffs, once a leading market concern, have faded somewhat from the headlines as their economic effects have yet to meaningfully impact consumers. Meanwhile, stocks rallied and continue to trade near record highs, buoyed by solid economic data. The Atlanta Federal Reserve’s GDPNow model currently forecasts GDP growth of 3.8% for the third quarter, up from an initial estimate of 3.3% earlier in the quarter.
Our Commentary:
After dipping on tariff-related headlines early in the year, the S&P 500 bottomed on April 8 at 4,982.77. Since then, markets have regained momentum, with strong rebounds in Q2 and Q3 pushing the index to new record highs. While some investors are raising concerns about a potential “melt-up”—a scenario where prices surge due to investor enthusiasm rather than fundamentals—we believe the data supports a more constructive view.
Several indicators point toward a fundamentally driven bull market. The Atlanta Fed’s GDPNow model projects a sharp acceleration in growth to 3.9%, initial unemployment claims remain low at 4.3% (BLS), and Q2 earnings surprised to the upside. Against this backdrop, the Fed’s decision to cut interest rates adds further stimulus.
The Fed’s primary concern appears to be the labor market. According to the Fed’s Summary of Economic Projections, officials expect unemployment to rise to 4.5% by year-end and anticipate two additional rate cuts in 2024, with a possible third in 2025. Given the Fed’s dual mandate—full employment (roughly 4% unemployment) and low inflation (targeting 2%)—the current rate cuts signal a clear emphasis on supporting jobs over curbing inflation.
The Fed has also expressed interest in returning rates to a “neutral” level around 3%, though this goal may prove elusive. Setting a target rate can provide useful structure, but clinging too rigidly to that target risks policy mistakes in a complex, dynamic environment. Responsiveness matters more than precision.
Corporate earnings in both Q1 and Q2 outperformed expectations, and importantly, the strength was not confined to the “Magnificent Seven” or AI-related names. Sectors like Financials and Consumer Discretionary also delivered strong results, according to Yardeni Research.
Looking ahead, analyst expectations for Q3 earnings have remained steady. However, if the Fed follows through with additional rate cuts, we may see those estimates revised upward. Combined with evidence that the rally is grounded in solid economic and corporate fundamentals, this strengthens our conviction that we are in a genuine bull market—not a speculative melt-up.
That said, the risk of policy missteps remains. If the Fed moves too aggressively, the added stimulus could overheat markets and spark the very melt-up some investors fear. Even if that occurs, we believe any subsequent correction would likely be a temporary setback in the broader, long-term growth story—especially as the AI revolution continues to unfold.
Until next quarter,
– Leelyn Smith Investment Committee
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