Market Activity
Equities, as measured by the S&P 500, had a strong third quarter, with the longer-term perspective masking an approximate 8% pullback in August. As noted in our previous writings, the August downturn was both severe and jarring, marked by a sharp decline in Japanese equities and a surge in volatility indicators. Yet, as we look at the market today, there seems to be little lasting impact. We anticipate that this may represent a new market paradigm: instead of taking weeks to fully digest, momentum-driven trades will now be quickly and sharply unwound.
Fixed income performed well this quarter, leading to an increase in trailing 12-month returns. We are pleased with our decision over the past 18 to 24 months to invest in intermediate-term securities. While these investments carried higher interest rate risk and initially offered lower yields compared to money funds, we believe we have reached the peak of bond yields in this cycle. Potential upward pressure on rates could come from a resurgence of inflation or market strain due to deficit absorption, although we consider both scenarios unlikely. Investors who locked in high bond yields are well-positioned, as money fund yields are expected to decline significantly in the coming quarters.
Economic Activity
The themes discussed in last quarter’s economic overview remain relevant today. Despite multiple forecasts predicting a slowdown, the U.S. economy has continued to demonstrate resilience. On the surface, a reasonable analysis suggests that the economy may have even improved since our last update.
The labor market remains a key focus, showing some signs of marginal improvement, according to data from the Federal Reserve Bank of St. Louis. Over the summer, initial jobless claims were rising, job openings were decreasing, and net payroll growth was stalling. Initial jobless claims peaked at 250,000 in July but have since decreased to 225,000. Job openings increased to 8.04 million in August, up 300,000 from July and holding steady with levels seen in April.
Regarding the upcoming election, we’ve received fewer inquiries than in previous cycles, which is understandable given the lack of significant policy concerns emerging from either candidate’s platform so far. The presidential race remains close, with the Senate leaning in favor of the Republicans (see details in the toggled section below), while the House of Representatives remains a toss-up. According to Goldman Sachs, GDP projections under a divided government scenario are expected to remain largely unchanged. However, in a sweep scenario, both parties could have a positive impact on GDP. A Democratic sweep is predicted to have the largest GDP boost, driven by an expanded child tax credit and increased consumer spending, while a GOP sweep would likely result in a more modest increase, balancing positive business investment against the impact of tariffs.
More significant for the market would be potential changes to corporate tax rates, which would likely require a complete sweep by either party to pass. According to Goldman Sachs, reducing the federal corporate tax rate from 21% to 15% (as proposed in the Trump plan) could increase earnings per share (EPS) by 4%. Conversely, raising the rate to 28% (as suggested in the Harris plan) would decrease EPS by 5%, with additional taxation on foreign income and a new business alternative minimum tax potentially reducing EPS by another 3%.
In summary, both parties’ plans contain offsetting influences. For significant market volatility to occur, a full sweep by either party would be necessary. A Republican sweep would likely be seen as a market positive, with the EPS boost from lower taxes outweighing the impact of higher inflation and interest rates resulting from increased tariffs. In contrast, a Democratic sweep might initially be viewed as a market negative due to the corporate tax hike but could be offset by stronger economic growth in the following quarters. In the intermediate term, we see factors like the Federal Reserve’s actions, advancements in artificial intelligence, and geopolitical developments as having a more substantial impact on equity returns.
Monetary Policy
With a 50 basis point (0.5%) reduction in September, the Federal Reserve has officially begun its easing cycle. As one of the last major central banks to start reducing interest rates, the key questions now are the target level and the speed of the journey. At the conclusion of its September meeting, the Federal Reserve Board projected a Fed Funds rate of 3.4% by the end of 2025 and 2.9% by the end of 2026 and beyond, compared to the current range of 4.75% to 5.00%. In a rare moment of consensus, the market is also forecasting a rate of 3.38% for December 2025.
The challenge now is whether the Fed can lower rates to a sustainable level without triggering a resurgence of inflation or significant job losses. This remains one of the most critical questions facing the economy and financial markets toda
Valuation & Sentiment
During the summer, much of the market conversation centered on the lack of breadth, with only a few stocks driving the bulk of the S&P 500’s gains. Less discussed, however, is the significant impact that a small number of companies can have on earnings growth. According to Refinitiv data, the top 10 companies are responsible for 80% of the expected 8% net profit growth in the S&P 500 this year. While this reliance on a select few companies for earnings growth may be concerning, it is still preferable to the market conditions of the 1990s, when market value was concentrated in a few stocks without the support of strong underlying profitability.
Investment Outlook & Strategy
Despite its historical reputation as one of the weakest months, September delivered attractive returns this year, with the early days of October showing a slight pullback. Currently, investor concerns center on three key issues:
- Uncertainty surrounding the upcoming election,
- The direction and speed of interest rate changes, and
- Whether the economy is headed toward a recession or a soft landing.
Here are our thoughts on these topics:
The Election: While the presidential race has far-reaching implications, our focus is primarily on the congressional outcome. A divided government—where one party does not control both the legislative and executive branches—would make it more difficult for either extreme legislation from the left or the right to pass, which could provide stability to the markets.
The Economy: We question whether the rapid pace of technological advancements has diminished the accuracy of traditional economic data, which was designed for a different era. Current data and surveys may not fully capture the effects of remote work and the productivity enhancements from smartphones, which provide constant connectivity and instant access to information. We believe that technological developments have increased productivity more than is widely recognized, directly impacting standards of living for savers and investors.
Demographics and the Baby Boomers: The current age range for Baby Boomers (born between 1946 and 1964) is 60 to 78 years old, with two-thirds already past retirement age and the remaining third approaching it. The question of who will fill these jobs is open, as younger generations lack the numbers required to fully replace the retiring Boomers. While this demographic challenge is significant, technology—particularly automation and AI—has the potential to mitigate its impact by increasing productivity and reducing the need for a large workforce. This transition, however, will require substantial investments in technology and workforce training.
Investment Outlook and Strategy: The economy has shown greater strength than most economists anticipated in recent months and years, possibly moving toward a growth rate that aligns with a neutral monetary policy—a stance that neither stimulates growth nor fosters inflation. While achieving a soft landing is historically challenging, careful policy management can make it possible. Assuming no significant economic shocks, the economy is likely to continue growing, leading to rising corporate revenues and earnings, which would support stock valuations.
Financial markets rarely move in a straight line; pullbacks and corrections are a normal part of market dynamics. Nevertheless, we believe that the foundation for higher growth is being set in areas like AI, robotics, and biotechnology, where demand continues to outpace supply. The next decade is likely to bring a wave of technological innovations that will touch all aspects of life. While challenges like cyber threats will persist, we remain optimistic that innovators will continue to stay ahead.
Portfolio Management Perspective: While we remain invested in the market’s upward movement, we do so with a defensive strategy. Even though a soft landing appears probable at this time, markets seem to have already priced in this outlook. As a result, we are focusing on defensive companies and selectively increasing cash reserves to take advantage of opportunities during inevitable periods of market weakness.
A Welcomed Alternative for Funds in 529 Plans
Starting January 1, 2024, as part of the SECURE Act 2.0, owners of 529 plans can roll excess funds into a Roth IRA for the beneficiary—a welcome change for many families. Previously, concerns about overfunding, the impact of scholarships, or a child’s decision to pursue a different path led some to hesitate in opening and funding these tax-advantaged accounts. While this new option provides relief to families looking to save for their children’s future, it may not be the right move for everyone. Here are some key provisions of the Act related to these rollovers:
- Annual Contribution Limits: Rollovers from a 529 to a Roth IRA are subject to the same annual IRA contribution limits set by the IRS. In 2024, the limit is $7,000 (or $8,000 for individuals aged 50 and older).
- Lifetime Limit of $35,000: The SECURE Act 2.0 establishes a lifetime limit of $35,000 per beneficiary that can be rolled over to a Roth IRA. This amount is expected to gradually increase over time.
- Account Age Requirements: The 529 account must have been open for at least 15 years, with contributions and earnings eligible for rollover required to be in the account for at least 5 years. Changing the beneficiary could potentially reset the 15-year rule, although this has yet to be confirmed by the IRS.
- Earned Income Requirement: Similar to Roth IRA contribution rules, the beneficiary must have earned income equal to or greater than the amount being rolled over. For instance, if the beneficiary earns $4,000 in a given year, the maximum eligible rollover amount is $4,000.
- No Income Limit for Rollovers: Unlike standard Roth IRA contribution rules, there is no earned income limit to perform the rollover, allowing beneficiaries of all income levels to take advantage of this opportunity.
While this rollover option is a valuable new feature, it’s important to consider the existing flexibility that 529 plans offer for handling excess funds:
- Change the Beneficiary: The 529 plan owner can change the beneficiary to another qualifying family member, such as a sibling, grandchild, niece, or nephew.
- Pay Off Existing Loans: Up to $10,000 of student loans can be paid off using 529 funds.
- Withdraw Up to the Scholarship Amount: If the beneficiary receives a scholarship, the custodian can withdraw up to the scholarship amount without penalty, although taxes on earnings will still apply.
- Withdraw the Funds: While families may be hesitant to withdraw due to concerns about taxes and penalties, it’s important to note that these apply only to the earnings, not the principal.
As Certified Financial Planners, we have the tools and expertise to guide our clients through their education planning options. Please feel free to contact us if we can assist you in any way.
DISCLOSURES – 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 dependable; however, its accuracy is not guaranteed and should not be relied upon in any way whatsoever. This presentation may not be construed as investment advice and does not give investment recommendations. Any opinion included in this report constitutes the judgment of Lincoln Capital Corporation as of the date of this report and are subject to change without notice. Additional information, including management fees and expenses, is provided on Lincoln Capital Corporation’s Form ADV Part 2. As with any investment strategy, there is potential for profit as well as the possibility of loss. Lincoln Capital Corporation does not guarantee any minimum level of investment performance or the success of any portfolio or investment strategy. All investments involve risk (the amount of which may vary significantly) and investment recommendations will not always be profitable. The investment return and principal value of an investment will fluctuate so that an investor’s portfolio may be worth more or less than its original cost at any given time. The underlying holdings of any presented portfolio are not federally or FDIC-insured and are not deposits or obligations of, or guaranteed by, any financial institution. Past performance is not a guarantee of future results. Lincoln Capital Corporation prepare presentation, 401.454.3040, www.lincolncapitalcorp.com Copyright © 2024, by Lincoln Capital Corporation.