Interest-Rate Forecast: What’s Next?

Ivanna Hampton: Here’s what’s ahead on this week’s Investing Insights. Interest rates have hit a 22-year high as inflation declines. I’ll talk with Morningstar’s senior U.S. economist about his outlook for interest-rate cuts. Plus, tips on how to manage your money if you retire earlier than you planned. And two tech heavyweights and the home of Barbie have reported their earnings. Morningstar analysts reveal whether Meta META, Microsoft MSFT, or Mattel MAT stocks are undervalued. This is Investing Insights.

Welcome to Investing Insights. I’m your host, Ivanna Hampton. Let’s get started with a look at the Morningstar headlines.

Meta’s “App-y” Family

Meta’s second-quarter earnings report shows the strength of its family of apps. Users increased across the board, and engagement remained healthy. Revenue reached $32 billion in the quarter, an 11% increase from last year. Ad revenue also hit double digits. Advertisers are gaining confidence in Meta’s enhanced and AI-powered campaign planning and measurement capabilities. And they’re spending more. The social-media giant’s cost cuts and efficiency led to year-over-year margin expansion for the first time since 2021. Morningstar thinks margin expansion will likely continue through 2027. Although, metaverse unit Reality Labs is expected to still rack up losses. Meta’s AI investments are focused on increasing user engagement, making ad placement more efficient, and improving ad returns on investment. Estimates put the number of Thread users early on at 100 million. However, it remains uncertain how Threads will make money and keep people using the text-based app. Morningstar believes Meta is worth $311 per share, up from $278. The stock appears fairly valued.

Microsoft’s Strong Q4

Microsoft reported solid top- and bottom-line fourth-quarter results. The tech company’s revenue grew 8% year over year to more than $56 billion. Important areas like Microsoft 365 and the Azure cloud platform are showing promise. Yet the company’s outlook overall fell short of Morningstar’s expectations. Microsoft is the clear leader in artificial intelligence, with demand materializing and looking to accelerate over the next couple of years. However, investments in AI will limit margin expansion for a while. But the growth opportunity makes that an easy trade. Morningstar is upping its estimate for what Microsoft stock is worth to $360 from $325. The analyst still thinks shares are trading at a compelling price.

Barbie Boost Could Fall

Barbie cruised to the top of the box office in her dream car, but the movie’s impact on Mattel’s success isn’t a sure thing. The toymaker reported second-quarter earnings that were better than expected. Sales dropped 12%, but that was less than Morningstar’s projected 18% downtick. The company reiterated its 2023 sales and earnings outlook. However, the stock could stall despite an increase in sales of dolls and other products related to the blockbuster. Consumers are dealing with an uncertain macroeconomic picture because of inflation. Morningstar thinks the toy company could see healthy top-line growth in the back half of this year. It’s shrugging off slow sales in the first half of 2022 because of supply chain concerns. Mattel has raised the Barbie brand’s visibility, and that could suggest future success in promoting other products beyond the toy aisle and on the big screen. But some of that buzz is expected to fizzle. That could pose a problem heading into next year when there’s little commercially to back up the Barbie boost. Mattel is also losing the executive credited with revitalizing the iconic doll brand. Richard Dickson is joining Gap GPS as its new CEO. Morningstar believes Mattel’s stock is worth $25 and undervalued.

Interest Rates Outlook

Interest rates sit at their highest level in more than 20 years. Inflation has dropped but still hovers above the Federal Reserve’s 2% target. Meanwhile, the U.S. economy is showing resilience. Morningstar Research Services’ senior U.S. economist Preston Caldwell has written about his outlook for interest-rate cuts. He’s joining Investing Insights.

Will There Be Future Interest Rate Hikes?

The Federal Reserve resumed raising interest rates in July. Fed Chair Jerome Powell hasn’t ruled out future hikes. Preston, what do you make of that?

Preston Caldwell: Yes. As widely anticipated, the Fed increased the fed-funds rate by 25 basis points in its July meeting. Now, even though it hadn’t increased the fed-funds rate in its prior meeting in June, this doesn’t mean the Fed has changed its mind or made an about-face in its strategy, it had always planned on skipping June with the understanding of probably hiking again in July, and so, things have gone according to plan in that sense. Now the question is, what’s coming next? Even though chair Powell does suggest that future hikes could be coming, I think the key phrase that he keeps repeating is how data-dependent the Fed is going to be. And we happen to think that the data is going to proceed in a way that pushes the Fed not to hike in its future meetings. And so we think the Fed is done hiking.

Inflation Is Falling

Hampton: So inflation is falling. What’s preventing it from hitting the Fed’s 2% target?

Caldwell: Well, we’re getting very close now. The CPI came in at 3.1% year over year in June. Core inflation is still running a bit higher, closer to 4% annualized in the past three months, and that’s important because core inflation, which strips out volatile food and energy prices, is held to be a better gauge on inflation’s underlying trend. With that said, though, even though we have seen a rebound in durable goods price inflation in the last several months, which has kind of kept core inflation from coming down more than it has, that does look like it’s starting to now finally unwind in the latest month. And there should be more of that in the pipeline with used car prices coming back down again. And so, all that should push core inflation lower in the next several months. And ultimately we think that broad-based deflation should continue over the next year, and we expect inflation in 2024 to come in line with the Fed’s 2% target.

The Economy is Strong

Hampton: So right now the economy remains pretty strong. What’s driving that growth?

Caldwell: Well, so it’s been several factors. At the beginning of the year, it was really strong consumption growth. Consumers have been dipping into the excess savings that were accumulated during the pandemic and spending those savings down. More recently, we’ve seen an abatement in the housing downturn, which had previously been weighing on growth. And then perhaps most importantly, in the last quarter, we’ve seen a jump in business investment driven by a boom in building new manufacturing facilities, which in turn appears spurred by the legislation passed over the last year, which allocated large subsidies for semiconductors and green energy and other industries.

How Long Will Economic Growth Last?

Hampton: And there’s talk of a recession or a slowing economy. How long do you think this economic growth will last?

Caldwell: Well, even though the economy has weathered rate hikes so far better than most would’ve expected, it’s still the case in our view that much of the effects of rate hikes have yet to fully play out. And one place that we see this is in the banking sector, where banks are still recalibrating their loan growth to respond to higher interest rates as well as outflow of deposits. And so, that means that loan growth is likely to decelerate. It has started to decelerate, and that’s likely to continue over the next year, and that contraction and bank loans will weigh on business investment and consumer spending to a lesser extent. And that will be one way in which the economy will continue to slow over the next year. And we expect GDP growth actually to arrive in the 0% to 1% range in the second half of 2023 and the first half of 2024, which is not recessionary, but it is below normal growth which will be, according to the Fed’s plan of cooling off the economy and taming inflation.

When Will the Fed Start Cutting Interest Rates?

Hampton: So that’s another data point that we need to watch. So Preston, you’re forecasting that the Fed will start cutting rates early next year. Explain why.

Caldwell: So given our view that inflation will come back to normal and also that growth and GDP will dip below trend, both of those factors will push the Fed towards wanting to cut rates in order to get the economy moving again. And ultimately, we think that the Fed can cut rates a good deal and re-stimulate economic growth without provoking a rebound in inflation because we see that supply chains are healing, the overall supply side of the economy is expanding in capacity as the disruption from the pandemic finally really fades. And that will allow the Fed to cut rates drastically in order to allow the economy to reach its full potential and not have to risk a rebound in inflation in our view. And so, we expect the federal-funds rate ultimately to dip all the way down to below 2% by mid-2025.

Hampton: All right. Well, Preston, thank you for your economic outlook today.

Caldwell: Thanks for having me, Ivanna. I enjoyed it.

Retiring Earlier Than Expected? How to Manage Your Finances

Hampton: A layoff, health issue, or caregiving responsibility could change your retirement plans. You may need to review your saving and spending habits to ensure your money lasts. Here’s Morningstar Inc.’s investment specialist Susan Dziubinski and Morningstar Inc.’s director of personal finance Christine Benz with the discussion.

Susan Dziubinski: Hi, I’m Susan Dziubinski with Morningstar. Many people will say they intend to work until age 65 or even longer, but data suggests that, in reality, many retire earlier than they expected. Morningstar’s director of personal finance and retirement planning, Christine Benz, is here to discuss what to consider if you need to retire earlier than you’d planned to.

Nice to see you, Christine.

Christine Benz: Hi, Susan. Great to see you.

Dziubinski: So, researchers have found that there can be this disconnect between when people think they’re going to retire and when they actually do retire. What are some of the key conclusions when you look at that research?

Benz: There have been numerous studies that have looked at this disconnect between when people thought they would retire and when they actually did retire. And so, when you look at the data, people in the preretirement mode, just 6% of them thought they would retire in their 50s, between the ages of 50 and 59. In reality, 30% or 29% of people, actually, those same people, actually retired in their 50s. Similarly, from the ages of 60 to 64, 19% of preretirees said, you know, “I’ll probably retire in that ballpark”; 31%, or almost a third, of these folks retired in that zone. So, generally speaking, we do see people needing to retire a little earlier than they expected, which is one reason why I always feel a little bit nervous when I talk to preretirees who say, “Yeah, it’s my plan to continue working until I’m 70 or even later than that.” As Mark Miller often says to us, “It’s a great aspiration. It’s not necessarily a plan.”

Dziubinski: Talk about some of the factors that may lead someone to retire earlier than he or she had planned.

Benz: There’s that sort of happy story, which is that if someone’s portfolio has performed really well, they’ve been a great saver, they may be able to retire earlier. We’ve been hearing this drumbeat of news about FIRE—the financial independence, retire early—where folks have been really aggressive savers in their working years. That’s the happy story. Less happy and, frankly, more common is when people are unable to work even though they intended to. So, they may have been forced to retire either because of layoffs or because they do a job that’s just physically untenable to do as they age. They may have encountered some health issue themselves or perhaps someone in their immediate orbit, a spouse, a parent, where working full-time at least is not possible, and they’ve been required to retire earlier than they expected.

Dziubinski: For those who find themselves in this situation of retiring earlier than might be ideal for them, what steps can they take to really try to make sure that those retirement assets will last their lifetime even though they have retired earlier than expected?

Benz: First step would be to line up some help. I think a lot of people in this position might say, “Wait, I don’t want to spend any money,” but this can really be money well spent. Buy yourself some peace of mind, buy yourself a plan, which is not to say that you can’t do some work on your own to figure out what your plan is. But I think buying financial advice at this life stage can be money well spent. It’s also worth negotiating, if you’re still in a position to do so, negotiate with your employer with the best possible exit package that you can, whether that means continuing health insurance in some fashion or maybe negotiating a good severance package. Then, if you’re pre-Medicare, you obviously want to look at what you will do for health insurance prior to Medicare kicking in.

Then spend some time looking at your anticipated spending. Also look at your income sources. And both of those things are going to ebb and flow more than we really talk about. We often talk about these guidelines, like the 4% guideline or whatever. We know in reality people’s income is moving around, so they might delay Social Security, for example, and that means that they’re having to spend more aggressively from the portfolio earlier on, less later on. And the actual spending can vary based on your own situation. So, spend some time plotting out really on a year-by-year basis what you expect those income sources to look like, what you expect your cash flow needs to be. And then spend some time looking at the sustainability of whatever that spending plan looks like. And we’ve done research on this topic, looking at sustainable safe withdrawal rates. Make sure that whatever plan you’ve come up with passes the sniff test on the sustainability front.

Dziubinski: Christine, you mentioned Social Security, and you think it’s important that someone not necessarily immediately assume, “Ooh, I need to claim Social Security” as the first thing they need to do when they find that they need to retire, right?

Benz: Right. And I understand the impulse, first of all, because if you’ve lost an income, you feel like job one is: How do I replace that income? But as people have heard us discuss many times over the years, the name of the game with Social Security is maximizing your lifetime payout. If you’re claiming prior to full retirement age certainly, and you can claim as early as age 62, that will potentially reduce your lifetime benefits. So, you need to really give thought to what is the optimal claiming decision if you’re someone who thinks that you have above-average longevity on your side, or maybe you’ve been the primary earner in your family and you have a younger spouse. It’s oftentimes a great idea to actually delay claiming Social Security with an eye toward enlarging that lifetime benefit. Do your homework on that front before claiming Social Security.

Dziubinski: Christine, what about those investors who maybe find that they have tighter financial plans and find themselves having to retire early? What are some ways that they can, as you would say, make a save in those cases?

Benz: One of the first things you can do is consider lifestyle changes. Obviously, relocating can be a big-ticket savings, especially if you live in a high-cost part of the country or if you live in a very large home that you don’t necessarily need. If you’re willing to consider some of those lifestyle changes, both big ones like relocating, as well as smaller-bore ones, like cutting some of your streaming services. Look at all of your budgetary items. Just make sure that they’re worth it to you. So, take stock of your budget. Also consider whether, even if you are not any longer working in your full-time job, see if you are willing to consider working in some capacity that can help forestall withdrawals from your portfolio. It can help support strategies like delaying Social Security claiming. So, lots of financial benefits associated with working longer, as well as some sort of personal quality-of-life benefits like maintaining connections, which we know are so important. So, investigate whether working in some fashion is an option for you.

And then, from a spending standpoint, when you’re thinking about your portfolio, I think you want to be careful about swinging for the fences in terms of making your portfolio really aggressive. Even though the stock market has performed well recently, it may not always be the case. But you do want to look at spending from the portfolio because research from us and from other entities that have examined safe spending in retirement have come down to this conclusion that if you’re willing to be flexible about your spending as retirement stretches on, that really redounds to the benefit of a higher starting withdrawal amount. So, investigate some of that research that we and others have done on flexible spending systems. Generally speaking, it does tend to support a higher starting withdrawal.

Dziubinski: Christine, thank you for your time today and for your tips on a very important topic that affects a lot of people.

Benz: It does, Susan. Thank you so much.

Dziubinski: I’m Susan Dziubinski with Morningstar. Thanks for tuning in.

Hampton: Thanks Susan and Christine. Subscribe to Morningstar’s YouTube channel to see new videos from our team. You can hear market trends and analyst insights from Morningstar on your Alexa devices. Say “Play Morningstar.” Thanks to video producer Daryl Lannert and lead technical producer Scott Halver. And thank you for tuning into “Investing Insights.” I’m Ivanna Hampton, a senior multimedia editor at Morningstar. Take care.

Read about topics from this episode.

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Microsoft Earnings: Solid Performance, With Azure Strength Offset by Margin Pressure in 2024

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Fed’s Powell Talks Tough After Rate Hike, But a Pause Seen Likely From Here

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