by Kristina Hooper, Chief Global Market Strategist, Invesco
Key takeaways
- Stocks and the economy - One myth is that an economy has to be in great shape in order for its stock market to perform well. That is simply not true.
- Gold and stocks - Another myth is that gold and stocks don’t perform well at the same time. There’s been some truth to that, but we’ve also seen exceptions, especially recently.
- Central bank strategy - Another myth is that central banks know what they plan to do well in advance of their meetings and that their “debates” are all performative.
I had the great pleasure of presenting at an event in Colorado Springs last week. On the ride back to the airport, I realized that my driver had an impressive command of local urban legends. One interesting tidbit he shared with me: Conspiracy theorists believe that alien bodies recovered from a 1947 UFO crash in Roswell, New Mexico, are now stored under the Denver airport (he explained that the government moved them out of Area 51 because it was attracting too much attention.) I must report that I quickly scanned my surroundings when I arrived at the airport, but saw no signs of an extraterrestrial storage facility. Then it occurred to me that my time is better spent dispelling the stock market myths and investing myths that I sometimes hear on my travels.
Myth #1: The relationship between the economy and stock markets
One myth is that an economy has to be in great shape in order for its stock market to perform well. That is simply not true. A case in point is the US in 2009. US gross domestic product growth declined 4.3% that year.1 However, the S&P 500 Index posted a gain of 23.45% in terms of simple price return and 26.46% in total return in 2009.2
Economic conditions can be somewhat weak, or even very poor, and stocks can still rise due to a variety of catalysts such as monetary policy easing, positive economic surprises, or positive earnings surprises. That’s why I believe in looking at areas of the stock market where there are “blemishes” and low expectations; those areas may have significant upside potential when there is some form of positive surprise.
An example is UK equities. Valuations have been very attractive, in my view — the MSCI UK Index price-to-earnings (P/E) ratio is 12.86 and its forward P/E is 11.66 — and the average dividend yield is quite robust at 3.64%.3 There is a lot of near-term nervousness around the Autumn Budget, which will be released at the end of the month, and longer-term negative sentiment about the potential of the UK economy given some structural headwinds. But I see the potential for positive surprise. The Budget may not deliver as high a tax burden as expected, or perhaps the very act of releasing the Budget and removing that uncertainty could be a positive catalyst for stocks. And there is also potential for some positive economic surprise. UK retail sales for September were better than expected, even though UK consumer sentiment has been declining recently. And UK unemployment moved lower in the most recent three-month period. In addition, the September inflation reading suggests there is more room to cut this year for the Bank of England, another possible driver of stocks.
It's a similar story for eurozone equities. Recent Purchasing Managers’ Index (PMI) surveys suggest economic weakness, but inflation has fallen significantly, suggesting more room for the European Central Bank (ECB) to cut this year as well. With valuations also relatively low — the MSCI Europe Index has a P/E of 15.2 — and a dividend yield above 3%,3 European equities have potential in this environment as well, especially given that earnings forecasts have been slashed on concerns about rising taxes and possible tariffs. Expectations are even lower now, so there is arguably more room for positive surprise.
Myth #2: The relationship between gold and stocks
Another myth is that gold and stocks don’t perform well at the same time. The theory behind this is that gold typically performs well in a “risk off” environment while stocks typically perform well in a “risk on” environment. Yes, historically, gold and stocks have had a low or negative correlation, albeit with a few exceptions, as investors have eschewed stocks and flocked to gold as a “safe haven” asset class during “risk off” environments.4 But that started to change during the pandemic, with gold becoming more closely correlated with stocks.4
And in recent months, gold has had a very high positive correlation with stocks.4 For example, last week gold hit another record high, crossing about the $2700 per ounce level, while stocks also hit record highs last week, with the S&P 500 Index closing at 5864.5 It seems that investors have a largely “risk on” stance in portfolios but are also hedging risk, especially geopolitical risk, with exposure to gold.
This is a good example of diversification in action. Investors can be “risk on” and participate in the capital appreciation potential of stocks but be “risk aware” by using gold to hedge against the downside risks of geopolitical uncertainty and turmoil. Having said that, gold is only one smaller component of a portfolio. I favor being well diversified and having exposure to other asset classes with historically low correlations to stocks.
Myth #3: Central bank strategy
Another urban legend is that central banks know what they plan to do well in advance of their meetings. I often come across people who believe that the Federal Reserve’s (Fed) “debates” during its regular meetings are all performative and that the Fed knows well in advance what it expects to do at each meeting. That is not true.
We’ve seen the Fed in recent years take many twists and turns in reacting to the data. For example, back in December 2021, the Fed’s dot plot anticipated the fed funds rate would be 90 basis points at the end of 2022.6 However, the Fed funds rate was actually more than 400 basis points at the end of 2022.7 That’s because the Fed and other central banks are data dependent, and the data was not what they expected.
Just last week, Fed Governor Chris Waller suggested the dot plot the Fed released at its September meeting may be somewhat obsolete, explaining, “I view the totality of the data as saying monetary policy should proceed with more caution on the pace of rate cuts than was needed at the September meeting.”
And this is true for other major central banks as well. For example, ECB President Christine Lagarde has also been clear that the ECB alters its policy path based on the data — although she makes the distinction that it is “data dependent” rather than “data-point dependent,” suggesting the ECB alters its policy based on economic trends.
A bonus myth: Elections and markets
Of course, another myth is that elections have a major impact on markets — an appropriate topic given that the US presidential election is just two weeks away. While elections can certainly cause short-term volatility, they tend not to have a significant impact on markets over the longer term.
For example, in the US, the S&P 500 has posted positive returns across most administrations, with few exceptions, since 1929. Those rare exceptions were presidencies that ended in deep recessions: the Herbert Hoover presidency, the Richard Nixon presidency and the George W. Bush presidency. All other presidencies since 1929 have posted annualized stock market gains of nearly 10% or more, although many experienced significant volatility along the way.8
It's also important to point out that markets haven’t historically performed the way one would expect given the policies of the party in power. For example, in 2021 and 2022, President Joe Biden signed into law three major bills that allocated significant money for infrastructure spending. However, both the materials and industrials sectors underperformed the S&P 500 Index in 20239 – despite this legislation helping to drive very substantial US construction spending on nonresidential structures, starting in 2022.
The reality is that, historically, monetary policy has mattered far more than who is in the White House when it comes to markets. For example, S&P 500 performance has been closely correlated to monetary policy cycles, with strong performance typically resulting from the end of a Fed tightening cycle. In six of the last seven tightening cycles, the S&P 500 has posted double-digit gains in the one-year period after the last rate hike.10 For all the focus on elections, historically, it’s been monetary policy that’s mattered more for markets.
Now one area of markets that can be affected by elections is Treasuries. Fiscal deficits and the overall size of the national debt are becoming a concern for some Treasury investors, and I think this is why gold has become the “safe haven” asset class of choice over Treasuries for many investors. I believe fiscal prudence could be a real positive for the Treasury market, but neither party has been able to claim that mantle in recent years.
Helping investors say focused
It can be fun to spend a long car ride wondering whether extraterrestrial life exists, and whether there’s been a long-standing conspiracy to hide evidence of UFOs. But those stories aren’t going to stop me from catching a plane from the Denver airport.
Unfortunately, stock market and investing myths can influence investors to rethink their decisions and miss out on growth potential in their portfolios. My goal with this column is to help investors sort out what’s going on in the economy and markets and make decisions based on truths and not myths.
Looking ahead
I’ll be very interested to see the Bank of Canada (BOC) decision this week. I expect the BOC will cut rates again. Inflation is relatively low in Canada – core Consumer Price Index inflation released last week for September is below the BOC’s 2% target. I think that, combined with some recent economic weakness, is enough for the BOC to cut rates by 50 basis points – which would be the fourth consecutive time in this easing cycle. This would contribute to an overall environment of monetary easing, helped along by a recent jumbo cut from the Reserve Bank of New Zealand. Supersizing isn’t just for Americans.
There are a few key releases I will be paying attention to, especially the Federal Reserve Beige Book, which provides insights into the state of the economy in the 12 Federal Reserve districts that comprise the United States. I will also be paying close attention to the University of Michigan Survey of Consumers. as well as flash PMIs for a number of major economies, which are important for relatively timely insights on economic activity. Finally, we will also get the most recent reading on UK consumer confidence – although we’ve seen consumers can be negative and still spend like they are rather happy.
Footnotes
1 Source: US Bureau of Economic Analysis
2 Source: Bloomberg
3 Source: MSCI, as of September 30, 2024
4 Source: Bloomberg. Over the last 20 years ending June 30, 2024, the correlation between gold and the S&P 500 was 0. The one-year rolling correlation as of Oct. 14, 2024 was 0.9. For the month of August 2024, the correlation between gold and the S&P 500 was 0.927 – the highest correlation for any month since November 2005.
5 Source: Bloomberg as of Oct. 18, 2024
6 Source: Federal Reserve Board of Governors, December 2021
7 Source: Bloomberg, as of Dec. 31, 2022
8 Source: S&P Global, as of Dec. 31, 2023. Biden Administration performance is through Dec. 31, 2023. Stock market performance is defined by the S&P 500 Index total return.
9 Source: Bloomberg as of Dec. 31, 2024
10 Source: Bloomberg as of July 31, 2023. The end of the Fed hiking cycles and the one-year return afterward are as follows: August 1984: 18.20%, February 1989:18.90%, February 1995: 35.60%, May 2000: -10.60%, July 2006: 16.10%, December 2018: 31.50%, July 2023: 18.23%.
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