Market Update | Higher and Higher

Higher market gains in June were fueled by continued strength in the job market, inflation slowly progressing lower, possible Fed easing in 2024 and artificial intelligence. Top heavy large cap equity returns narrowed further as chip maker Nvidia (NVDA) briefly surpassed Microsoft (MSFT) mid-month to become the most valuable U.S. company at $3.34 trillion. The month of June included both a stronger than expected labor market data release and mild inflation reading, cumulating in the Fed maintaining their current restrictive monetary policy stance of ‘higher for longer’. The Fed’s quarterly dot plot chart, which records Fed official’s projections for the federal funds rate, is now signaling a median of just one rate cut in 2024 despite pressure from central banks internationally. Seemingly unaffected by the interest rate outlook and fueled by cash rich Big Tech stocks, the broader S&P 500 index was up a staggering 15.3% six months into the year. The S&P 500 added 3.6% in June gains while the Dow Jones Industrial Average (DJIA) gained 1.2%. The tech-heavy NASDAQ rose 6%. Longer-term bond yields fell for the second consecutive month, with the 10-year treasury falling to 4.36% from 4.51%. The inverse nature of falling rates lead to a 1.0% gain in the Barclay’s US Aggregate Index in June. 

The unemployment rate rose to 4% despite 272,000 jobs being added in May, a 30% increase from 190,000 jobs forecasted by economists. This comes after many forecasters expected hiring to continue at the newer, slower pace seen in April. The upward revision to April’s 175,000 job report could mean the Fed’s anti-inflation campaign is not yet dragging on business and consumer spending. This would also mitigate, for now, concerns associated with an abruptly softening labor market on the broader economy. May unemployment edged up to 4%, which remains low when compared to a 76-year historical average of 5.69%. The exact reason for a seemingly impossible increase in unemployment while adding additional jobs is not confirmed. Leading theories point to the recent immigration surges beginning to filter into the monthly employment surveys of around 119,000 U.S. businesses. While the unemployment rate is determined by a rotating survey of roughly 60,000 households, explaining the disjointed and occasionally conflicting nature of these two crucial surveys.

The lack of breadth in current U.S. equity returns have cumulated in two resounding drivers of market movement. The first has been demand for microchips, fueling the artificial intelligence race to dominance. The second, with far less idiosyncratic risk, is concerns regarding the economy and interest rate impacts on inflation. Diving into the U.S. Bureau of Labor Statistics May Consumer Price Index Summary, The Consumer Price Index (CPI) came in lower than expected, remaining unchanged from the previous month and up 3.3% from one-year earlier. This comes after a lack-luster month over month rise of 0.3% in April. Core CPI, which omits the traditionally volatile food and energy baskets, rose 3.4% over the past year. This is a 0.2% rise from the April reading but represents the mildest increase in Core CPI since 2021. Shelter increased 0.4% in May and was the largest factor in the monthly increase for Core CPI. The Fed’s preferred inflation gauge, the core Personal Consumption Expenditures (PCE) Index, came in at 2.6% at the end of June. Core PCE rose 0.1% in May, which will be a welcome sight for the Fed following a 0.3% increase in April. This is an encouraging sign that the broader price pressures measured by PCE may be moderating for a still chary Fed.

The Fed kept rates steady at the 5.25% to 5.50% range, a move that was anticipated given that inflation has remained sticky above their 2% target. June’s quarterly economic projections showed 15 of 19 Fed officials penciling in reduced rates this year, with the group split between one or two rate cuts. Expectations that Fed officials will cut at one of the four remaining meetings this year heightened following decisions by the European Central Bank (ECB) and Bank of Canada (BoC) to decrease rates for the first time since 2019 and 2020 respectively. Their respective 25 basis point rate cuts have been met with some criticism for a lack of positive incoming economic data backing the decision. Overall, economic growth has been weaker abroad than in the U.S., where many homeowners have been shielded from the effects of higher interest rates because they locked in ultralow 30-year, fixed-rate mortgages in 2020 and 2021.

Before the May inflation data was released in early June, investors predicted a 47% chance the Fed would cut rates by 25 points in September. Most recent readings now predict a 56% chance of that happening, according to the CME FedWatch Tool. Fed officials will have three more inflation reports to digest by their September meeting before the November 5th presidential election to consider a change to the fed funds rate.  This decision will be a key factor in determining if the broader market will participate in the earnings growth that we have seen from the current bull run by predominantly the technology sector.

Legal Update | Overview of the U.S. Department of Labor’s New Retirement Security Rule for Investment Advice Fiduciaries

On April 23^rd, the U.S. Department of Labor (DOL) published a new fiduciary investment advice rule, the Retirement Security Rule, under the Employee Retirement Income Security Act (ERISA). This rule redefines fiduciary investment advice under ERISA by amending the regulations that have been in place since 1975, as well as some pre-existing corresponding prohibited transaction exemptions (PTEs).

The new rule provides that a financial services provider will be an investment advice fiduciary if the:

• provider makes an investment recommendation to a retirement investor;
• recommendation is provided for a fee or other compensation, and
• financial services provider holds itself out as a trusted adviser by
  • specifically stating that it is acting as a fiduciary under ERISA; or
  • making the recommendation in a way that would indicate to a reasonable investor that it is acting as a trusted adviser making individualized recommendations based on the investor’s best interest.

 When does the rule take effect?

The new provisions will start to take effect on September 23, 2024; however, some of the requirements under the amended PTEs will take effect in 2025. 

 Who does the new rule apply to?

The rule applies to financial institutions and any persons who give professional investment advice on retirement savings plans, including traditional pension plans, 401(k)s, 403(b)s, and IRAs.  The investment adviser must provide advice that’s in the plan’s best interest and in the best interest of any individuals to whom they provide advice based on personal circumstances.  This means they must follow the rule’s requirements to provide prudent, loyal, and honest advice. 

 My advice provider is currently a fiduciary. What do they have to do?

Under the rule and amended PTEs, investment advisers will have to:

• Acknowledge their fiduciary status in writing;
• Disclose their services and any material conflicts of interest;
• Adhere to the Impartial Conduct Standards under PTE 2020-02 requiring them to:
  • investigate and evaluate investments, provide advice, and exercise sound judgment in the same way that knowledgeable and impartial professionals would in similar circumstances;
  • never place their own interests ahead of the retirement investor’s interest, or subordinate the retirement investor’s interests to their own;
  • charge no more than reasonable compensation; and
  • avoid making misleading statements about investment transactions and other relevant matters;
• Adopt firm-level policies and procedures prudently designed to ensure compliance with the Impartial Conduct Standards and mitigate conflicts of interest that could otherwise cause violations of those standards;
• Document and disclose the specific reasons for any rollover recommendations; and
• Conduct an annual retrospective compliance review.

 What kind of activities are not considered fiduciary investment advice under the new rule?

Plan sponsors and their service providers can continue to provide nonfiduciary investment education by providing general financial and investment information to participants without having to adhere to the new rule. In addition, routine communications to plan participants such as the implications of taking participant loans or hardship distributions, and the need to take a required minimum distributions would not be considered investment advice recommendations under the new rule. 

DOL Resources:

• Retirement Security Rule: Definition of an Investment Advice Fiduciary
• Fact Sheet: Retirement Security Rule and Amendments to Class Prohibited Transaction Exemptions for Investment Advice Fiduciaries
• Understanding the Retirement Security Rule: For Investors