3Fourteen Research's Warren Pies: Lower rates means you don’t want to be underweight equities

Key Concepts

• S&P 500 target of 6800 by 2025
• Impact of Fed policy on equity markets
• Growth scare: anxiety around a recession that doesn't materialize
• Portfolio allocation strategy: overweight bonds paired with equities
• Soft landing: Fed's attempt to manage the economy without causing a recession
• Real fed funds rate: nominal fed funds rate minus inflation projection

S&P 500 Target and Market Outlook

• 314 Research maintains its S&P 500 target of 6800 for 2025.
• This target is approximately 2% from current levels.
• The target was initially considered optimistic but now appears more attainable.

Impact of Fed Policy

• Two positive developments from the Fed this week:
  • The rates market had priced in more cuts than the Fed signaled in June. Instances where the Fed moves slightly towards market expectations (but not fully) are historically positive for equities in the following quarter. Examples include September and December 2023.
  • The Fed is lowering its real fed funds rate (nominal rate minus inflation projections for 2025-2027). This environment is generally favorable for equities.

Portfolio Allocation Strategy

• The firm is bullish but also focused on risk management.
• The primary concern is a potential growth scare, not inflation or bond market issues.
• They estimate a one-third chance of a growth scare in the coming months, which could lead to a 7-8% pullback in equities and increased volatility.
• To mitigate this risk, they recommend pairing long equity positions with an overweight bond position.
• In the event of a growth scare, they anticipate the 10-year Treasury yield could fall below 3.5%.

Defining and Understanding Growth Scares

• A growth scare is defined as a period of anxiety around a recession that ultimately does not occur.
• It typically involves a slight increase in the unemployment rate that later stabilizes.
• Growth scares often occur during soft landing attempts by the Fed.
• Historical examples include the mid-1960s, mid-1980s, 1995, 2018, and the previous year (August sell-off).
• Characteristics of a growth scare: declining interest rates, flattening yield curve, slight increase in unemployment.
• Equities still perform well when viewed in the long term, but experience increased volatility and drawdowns (around 7-8%).

Fed's Perspective and Labor Market Concerns

• The Fed may be more concerned about the labor market than they publicly express.
• The speaker suggests the Fed sees a larger "left tail" risk for the labor market.
• This concern is reflected in Powell's comments during the press conference.
• Investors should prepare their portfolios for potential labor market weakness.

Synthesis/Conclusion

The speaker maintains a bullish outlook on equities, targeting an S&P 500 level of 6800 by 2025. However, they emphasize the importance of risk management, particularly the potential for a growth scare. They recommend a portfolio strategy that combines long equity positions with an overweight allocation to bonds to hedge against this risk. The speaker believes the Fed is more concerned about the labor market than it publicly admits, and investors should prepare for potential economic slowdown.