A Tale of Two Very Different Months

A kinder, gentler Fed

December was a bad month for stocks. There’s no way to sugarcoat it. Long-term investors recognize the need for disciplined approach, but that doesn’t mean extreme levels of volatility won’t create some degree of concern. I get it.

We touched a bottom on Christmas Eve, and shares extended gains into January. In fact, the Wall Street Journal ran an article stating the S&P 500’s advance last month was the best start to the year since 1987.

Market Returns 2-11-19.jpg

Much of the data suggests the economy continues to expand, but one important reason the bull market is waking up from its late-year slumber is the Federal Reserve.

In December, the Fed was talking about “gradual” rate hikes–possibly two this year. I placed gradual in quotes because that’s how the Fed phrased its guidance.

In late January, just six short weeks later, the Fed said it can be “patient” as it ponders the direction of rates. Yes, that’s right–the direction. When Fed Chief Jerome Powell was asked at his late-January press conference whether the next move in rates might be up or down, he didn’t tip his hand. Instead, he said it all depends on the economic data.

At this point, the Fed’s on hold–no more rate hikes, at least through the shorter term and maybe longer.  Discussions about an “inverted yield curve” for bond markets came up a lot in the 4th quarter and there was a lot of talk about possible recession in 2019 or 2020.  Historically when that spread between longer term (e.g. 10 years) and shorter term (e.g. 2 years) gets less, banks have less of an incentive to borrow at short term rates to lend out at longer term rates and “lending standards” tend to get more restrictive, making money less available to consumers and businesses to get money to do the activities that lead to economic growth, which can obviously lead to recession.  That is a simplified overview, but hopefully one that helps with understanding what that means when you hear about it.  The chart below shows the history of those 2 components and how they’ve interacted with previous recessions.  As the orange line (the difference between 10 yr and 2 yr) approaches zero, banks have historically tightened their lending standards and that has preceded recessions.

Yield Curve 2-11-19.png

It’s not that economic growth has stalled or even slowed considerably. The latest 300,000+ payroll number provided by the U.S. BLS would suggest the economy is not weakening.

But various surveys of consumer and business confidence have eased (University of Michigan survey, Conference Board, Wall Street Journal), and economic growth has slowed a bit around the globe.

Throw in a cautionary signal in the market decline from investors late last year (fears the Fed was poised to tip the economy into a recession if it continued to tighten the monetary screws), and the Fed shifted its stance.  How did tweets from the President impact some of this softening?  Hard to say, but he has been open about criticizing the Fed regarding rate increases as he certainly wants the economy & markets to keep clicking.  It is an unprecedented time of involvement in these matters from the White House.

The Fed stance now seems to be the main catalyst for the challenges experienced by the markets in the 4th quarter.  Other primary issues, including trade talks with China and government shutdown related to border security funding at least seem to have some promise of progress in the weeks and months ahead.  While we will certainly be keeping an eye on all of these issues and economic data, current indicators have both our strategic and tactical portfolios invested.

If you have any questions or would like to discuss any matters, please feel free to email back or give me a call.  As always, I’m honored and humbled that you have given me the opportunity to serve as your financial advisor.

 

Thanks to Horsesmouth for portions of the info above