Time to read: 5 minutes |
“Don’t fight the Fed” is one of our rules of tactical investing. This year it’s been easy to observe Federal Reserve policies directly affecting capital markets. The Fed pivot on January 5 ignited a stock-market rally that took some of the US averages, such as the S&P 500 and the NASDAQ Composite, to new highs in 2019. This happened despite a lack of fundamental improvement in key areas of concern for investors.
As trade tensions flared recently, with the potential for a second front with Mexico, the Fed came to the rescue again. On June 4, the Chairman of the Federal Reserve, Jerome Powell, indicated the possibility of interest-rate cuts if recession risks rise. Stocks again jumped on the news that the central bank is prepared to support the US economy if trade tensions give way to softer economic data. This helped reverse a monthlong 6.8% decline in the S&P 500. Stock prices have historically tended to rally after the beginning of easing cycles, with the Dow Industrials up an average of 10.4% six months later (see chart below).
Note, however, that the most recent two easing cycles (2001 and 2007) failed to ignite the market. If Fed rate cuts happen too late and other forces are too strong, the Fed will be “pushing on a string”. As we have written, recent data has not yet shown substantial improvement in the slowing global economy. In addition, the U.S. economy has turned out weaker-than-expected numbers, as can be seen in the Citigroup U.S. Economic Surprise Index (below).
This index is shown in red on the chart. The blue clip illustrates the performance of the S&P 500, for reference. It measures how much economic data from the past three months is beating or missing the median estimates in Bloomberg surveys. As you can see, the first half of 2019 has generally produced economic data on the low end of analysts’ expectations – a bearish signal.
While we welcome Federal Reserve policy which is flexible and accommodative, monetary policy should take a back seat to economic data and trade discussions. Market movement likely hinges on trade tensions, which still appear heated, and economic data, which has disappointed. The weight of the evidence still calls for a somewhat cautious approach to tactical investment decisions going into the summer months.
