U.S. equities have surged in recent months, with the S&P 500 climbing ~15% year-to-date after a shaky first quarter. Despite concerns including trade tensions, government shutdowns, geopolitical risk, and government deficits, the rally has continued. What’s behind this? It comes down to the government and the Federal Reserve both pushing the economy forward in a way that’s amplifying growth.
Usually, when the economy is running with low unemployment and steady growth, the Fed raises interest rates to prevent things from overheating, and the government might cut spending to shrink deficits. Today, however, that’s not the case. The Fed has resumed cutting rates, down to around 4% in September, while the broader economy continues to show resilience. Additionally, the government is running a massive deficit, expected to hit nearly $2 trillion this fiscal year – this procyclical approach, where both policies fuel expansion, creates a powerful boost for stocks.
Despite growth surprising to the upside, labor market health has weakened significantly, shifting the Fed’s focus from inflation to labor. Unemployment has crept up to 4.3%, with fewer new jobs and longer hiring times, but it is still not near recessionary territory. In addition, credit spreads remain narrow, signaling sustained risk appetite despite the slowing job market. Currently, the market is pricing in a strong probability of two more rate cuts this year. As AI enthusiasm and demand persist, lower borrowing costs from tight spreads and Fed cuts would add further fuel to the ongoing massive capex cycle and boost corporate profits. This procyclical policy environment has driven a “melt-up,” where rising asset prices attract an increasing number of investors.
The leap upward in risk assets comes with risks. Loose monetary policy and high investor confidence can inflate asset prices too far, setting up more drastic corrections when conditions tighten. However, rather than pursuing the problematic task of timing a market top, we recommend investors stay invested in line with their risk profile so they do not miss out on the near-term upside. While market corrections are inevitable, the current rally shows no signs of slowing just yet. Intraday dips are quickly bought up, with US indices reaching all-time highs nearly every week. Those sitting out the rally and waiting for a better entry point may find themselves waiting for quite a while, not to mention earning less cash each month. In such an environment, matching your risk profile and diversifying the risks taken to generate returns is, in our view, the better strategy.
DISCLOSURES
The information provided is for educational purposes only. The views expressed here are those of the author and may not represent the views of Leo Wealth. Neither Leo Wealth nor the author makes any warranty or representation as to this information’s accuracy, completeness, or reliability. Please be advised that this content may contain errors, is subject to revision at all times, and should not be relied upon for any purpose. Under no circumstances shall Leo Wealth be liable to you or anyone else for damage stemming from the use or misuse of this information. Neither Leo Wealth nor the author offers legal or tax advice. Please consult the appropriate professional regarding your individual circumstance. Past performance is no guarantee of future results.
This material represents an assessment of the market and economic environment at a specific point in time. It is not intended to be a forecast of future events or a guarantee of future results.
Indices are unmanaged and investors cannot invest directly in an index. Unless otherwise noted, performance of indices does not account for any fees, commissions or other expenses that would be incurred. Returns do not include reinvested dividends.
The S&P 500 Index is a market capitalization–weighted index of 500 common stocks chosen for market size, liquidity, and industry group representation to represent US equity performance.
The Morningstar US Market Index measures the performance of large-, mid- and small-cap stocks in the U.S., representing the top 97% of the investable universe by market capitalization.
Diversification does not guarantee a profit or protect against a loss in a declining market. It is a method used to help manage investment risk.
