“What does patient mean? ... Patient means that we don’t feel any hurry to change our interest rate policy.”
— Jerome Powell on 60 Minutes, March
Based on the recent televised interview with Federal Reserve Chairman Jerome Powell, many analysts believe interest rates are done going up this year.
After hiking rates four times last year, the Fed is in wait-and-see mode.
If you want to kill an economic expansion, you raise interest rates. Looking at the leading factors contributing to recessions over the last 60 years, tighter monetary policy leads all other causes — more than three times as likely as oil price shocks, banking crises or poor fiscal policy.
Over the last two years, the Fed has hiked rates eight times, driving short-term interest rates up 2 percent. Last fall, the Fed hinted at even more hikes in 2019 — until the market fell 20 percent in the last few months of 2018.
For now, the Fed has surrendered. And for now, this makes sense.
The huge inventory surge last summer driven by purchasing managers trying to get ahead of potential tariff increases created a surge in economic activity followed by a natural lag in future orders. As the U.S.-China trade detente drags on, the natural recovery in order patterns has only sputtered along.
As a result, global growth is slowing, with U.S. inflation measures still coming in below the Fed’s 2 percent target. This gives them room to pause on rates for a while.
Some analysts believe rate hikes are off the table until the 2020 election. Historically, the Fed tries to stay on the sidelines during election season in an effort to not tilt the presidential election one way or another.
So we could see flat short-term rates for another 18 months or so. This, combined with a gradual runoff of the Fed’s holdings of mortgage-backed securities, has led to a steepening of the yield curve. This is healthy for the economy.
While the market has bounced on this shift in sentiment and an expectation of some U.S.-China trade deal, investors are far from euphoric. There is still a lot of investor anxiety, which is typically not consistent with the end of the economic cycle.
When investors feel they can’t lose in the market, that’s the sign things are coming to an end. Psychology seems to be a ways off from peaking.
Another interesting measure of market health is also flashing green. Over the past few years, more and more gains were driven by just a handful of high-flying tech stocks.
The rally so far in 2019 has been more healthy. The S&P 500 Equal Weight Index (which removes the size of the company from its allocation weighting, instead treating each company equally) is a decent gauge of how broadly the recent rally is affecting various stocks.
Since January, the Equal Weight Index has outperformed the benchmark S&P 500 — a nice sign of a healthy market.
We added substantially to our holdings in the fourth quarter, taking advantage of the lower prices to add more market exposure on the cheap. As markets have recovered, we have harvested some of the gains but remain long the market, allocated much more heavily to “value” rather than tech-heavy names with lofty prices.
Risks still remain. If a U.S.-China accord does not come together in the coming months, or if the Fed begins hiking rates in the face of softening economic data, the positive conditions outlined above will have been unwound. With volatility returning to levels seen early last fall, hedging appropriately still makes sense.
But with the election still a ways off, the markets have several tailwinds at their back.