After soaring through the first seven months of 2023 in one of the strongest rallies ever, stocks have cooled off in August. So far this month, the Dow Jones, S&P 500, and Nasdaq are all in decline.
The big debate now is whether this is just a short-term pullback in a long-term uptrend – or the start of something much more sinister.
Our latest fundamental research strongly suggests the former.
If you regularly read our analysis, you know that we scrutinize the market through every lens that we can think of.
We’ve analyzed it through the lens of earnings, breadth, technicals, yields, and more.
Thus far, all that analysis has arrived at the same conclusions:
- Rates and yields are maxed out.
- Economic activity has bottomed.
- Stocks are primed to soar into 2025 (at least).
But yesterday, for the first time ever, we conducted a comprehensive fundamental analysis on the market by focusing on a little-known yet super-important factor: the natural interest rate.
This may be the most important number you’ve never heard of before.
Understanding the Natural Interest Rate
The natural interest rate – or neutral interest rate – is the real interest rate in the U.S. economy that neither stimulates nor contracts the economy. It is the theoretical “perfect” real interest rate to support the economy at full employment while keeping inflation constant.
The natural interest rate is commonly denoted as R*.
While R* is not observable, there are multiple well-proven statistical models to estimate it. The most well-established of these is the Holston-Laubach-Williams (HLW) model. That model uses a variety of economic signals to estimate R* on a quarterly basis.
The most recent estimate from the HLW model is the Q1 estimate of 0.58%. In other words, the natural interest rate for the U.S. economy is presently estimated to be about 0.6%.
In the 1960s, R* was around 6%. But as economic productivity improved and natural inflationary pressures eased, it trended downward through the end of the 20th Century. Following the 2008 financial crisis, R* collapsed and stabilized around ultra-low levels of ~0.7%. Briefly, after the COVID-19 pandemic, R* spiked above 1%. And now it has fully returned to (and is actually below) pre-pandemic levels.
This is very important because the Fed has long said that once inflation does sustainably return to 2%, it wants to return the Fed Funds rate to the nominal neutral rate.
And of course, the nominal neutral rate is the real neutral rate plus the inflation rate – or R* + CPI.
It makes sense that the Fed wants to return rates to that level once inflation is eradicated because the sum of R* and CPI has always closely tracked the Fed Funds rate.
So, what does it mean if the Fed Funds rate drops back to the nominal neutral rate over the next two years?
Why Rate Cuts Are Likely In Our Future
Let’s say R* stays around 0.5%. Let’s also say CPI returns to 2% within the next two years. That puts the sum of R* and CPI at 2.5%. The current Fed Funds rate is 5.25%. In order for the current Fed Funds rate to drop to the nominal neutral rate of 2.5%, the Fed would have to cut rates by 10 or 11 times over the next two years.
No wonder the market sees the Fed cutting rates a bunch into 2025. The Fed itself thinks it’ll be cutting rates next year, too.
Put simply, the Fed is very likely to cut interest rates starting next year and lasting into 2025.
What does that mean for stocks?
Well, so long as the economy avoids a recession, it means a stock market boom in 2024 and ‘25.
That is, the impact of rate cuts on the stock market is unclear because it depends on the economic context. Of course, when the Fed is cutting rates to fight a deep recession, stocks drop during the rate-cut cycle.
But every once in a while, the Fed will cut without a recession just to return rates to a neutral level.
When that happens, stocks boom.
An Incoming Stock Boom?
That is, whenever the Fed cuts rates and the economy avoids a recession, the stock market surges.
This happened in the mid-1980s and mid- and late 1990s. Most recently, it happened in 2019.
And every time, stocks soared.
It seems rate cuts + stable economic activity = stock market boom.
Therefore, it is reasonable to assume that if the Fed cuts rates over the next two years and the economy avoids a recession, stocks will soar.
The key question, then, is: Will the economy avoid a recession?
We think it will.
Our favorite indicator of future economic health is the Conference Board’s Leading Economic Indicators index (LEI). It is the most comprehensive and accurate indicator of the U.S. economy.
And the LEI suggests the economy will improve over the next two years.
In 2022, the LEI crashed, but it has stabilized in deeply negative territory here in 2023. Typically, when the index stabilizes like this, it takes a sharp turn higher and rebounds strongly over the following one to two years.
It increasingly looks like the economy has turned a corner. The worst of the economic slowdown appears to be over.
And it seems we’ve successfully avoided a recession.
The Final Word on the Natural Interest Rate
With a recession averted and rate cuts on the way, the stock market is primed to soar over the next two years.
Therefore, the August volatility we’ve seen in the stock market is just a healthy and natural short-term pullback in a long-term uptrend.
Take advantage of the pullback, and buy the dip.
And when stocks resume their uptrend, watch as the gains roll in.
Though dip-buying isn’t the only way to position your portfolio for those coming mega gains.
That’s why, today, I’m going to tell you about a ‘loophole’ I discovered that will allow you to invest in the company that kickstarted this whole stock market rally – OpenAI, the creator of ChatGPT.
Since ChatGPT’s launch in November 2022, OpenAI’s valuation has already doubled.
But this is just the start.
I truly believe OpenAI could be one of the world’s largest companies in the near future – if not the largest.
If so, this is your chance to invest in the next big thing.
Like investing in Apple (AAPL) in the 1980s or Amazon (AMZN) in the 1990s, this is an opportunity you can’t afford to miss.
On the date of publication, Luke Lango did not have (either directly or indirectly) any positions in the securities mentioned in this article.
