The market has reached another all-time high, with the S&P 500 crossing the 3,500 mark, for an almost 7% gain this past month. What’s interesting is that we are also seeing an increase in the VIX, or volatility index. We discussed that on a previous edition; in short it tells us how much stocks are moving up and down. Generally speaking, stocks rise in periods of low volatility. We would expect to see the VIX flat or declining given the rising market. Some of this dichotomy is happening due to the impact of megacaps, or the ultra-large companies at the top of the S&P 500. As we discussed last week, those companies are driving much of the rise in the index.
We also have three big things happening in the market right now: stock splits, a major change in Fed policy, and changes to the Dow Jones Index.
Both Tesla and Apple have had recent stock splits. One August 21st, Tesla had a 5 to 1 split, and on August 24th, Apple split 4 to 1. So what is a stock split? Let’s take Apple as an example. Prior to the split, it was trading at a about $500 a share. If you owned one share of Apple on August 23rd, you woke up the next morning and owned 4 shares of Apple. Each share was then worth about $125 a share. Companies split their stock to make shares more affordable; it’s easier to buy a share of Apple at $125 than it is at $500. Stock splits don’t affect your taxes, either. If you had bought the single share at $200 prior to the split, that cost basis splits as well, and each share after the split has a cost basis of $50.
On Thursday, the Federal Reserve Bank announced a major policy change. It’s important to realize that, unique among central banks, the Fed has a dual mandate. They are tasked with both managing inflation and unemployment. The Fed has a target inflation rate of 2%. The first tool in their tool box is interest rate changes; we see this reflected in the prime rate.
Traditionally, the Fed has felt it is a balancing act between the two mandates, and that full employment, especially what we were seeing pre-Covid, automatically led to increased inflation. We saw this play out when the Fed raised interest rates by a total of 2% from December 2016 through the end of 2018. Inflation was not an issue, but the unemployment rate continued to drop. In fact, inflation averaged only 1.6% over the last five years.
Last week, Jerome Powell, the Federal Reserve Chairman said that they will target an average inflation rate of 2% over time, not all the time, and that the Fed will not feel obligated to raise rates even if we are running at full employment levels. The Fed generally defines full employment as an unemployment rate of approximately 4%.
What does that mean? Interest rates aren’t going up any time soon. For borrowers, this is great news. If you haven’t considered refinancing your mortgage, this is a great time to do so. While carrying a balance on a credit card is generally not a positive financial move, average rates are down to about 16%. For savers, this is not great. And that’s the point. By keeping interest rates low, the Fed hopes to make it cheaper for companies to find capital to grow, and for investors to provide that capital, as they seek out higher returns.
And happening this morning, the Dow Jones Index has a change in their line-up; three new companies will be joining the 30-stock benchmark. Salesforce.com will replace Exxon Mobil, Amgen will replace Pfizer and Honeywell International will replace Raytheon Technologies.
The shake-up was prompted by Apple’s decision to enact a 4-for-1 stock split, which would significantly reduce the benchmark’s exposure to the information technology sector.
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