The last three months have comprised the most abrupt shift in market sentiment we have seen with most commentators and participants now sounding despondent after euphoria ruled the day only a short time ago. As we have been discussing for a long time, the market environment had become unsustainable.
2018 was the year that most stocks and asset classes came under increasing pressure below the surface of the indices without much notice until the fall. With growth now a worry, those who were singing praises about stocks and the economy for most of the year are begging the Fed to stop raising fed funds when real rates are barely positive instead of the 2-3% usually required to slow things down.
Yesterday, the Fed decided to raise rates to 2.25-2.50%, but tempered expectations for further increases next year in response to recent events and criticism. However, balance sheet reduction will continue as planned for now. All in all, Mr. Powell was not sympathetic enough for many investors and we respect that because the markets have lacked proper discipline for years. That said, he will likely become more dovish once he realizes that the landscape has changed more than he thinks.
Oil’s collapse and a dire warning from FedEx yesterday about slowing demand are the latest signals that the economy is not robust. It is always funny to hear various commentators say thing like “housing (autos, package delivery, etc.) can’t be slowing down because GDP growth is so strong.” Sometimes it pays to question the premise.
Tax cuts were supposed to be the key driver or marginal distortive stimulant in 2018. That has not worked out so well as we suggested would be the case. Republicans did not even mention tax cuts much during campaign season because they were a dud for much of the electorate. Capex did not go gangbusters and stock buybacks lost their mojo.
We did not expect investors to walk along the edge of the cliff for so much of the year, but that’s what happens when central banks and Wall Street push narratives that strongly encouraged speculation. Growth was helped by hurricane rebuilds, inventory stocking ahead of tariffs, and deficit spending. Unsustainable though they were, they provided fuel for those bullish narratives through the summer and into the fall.
We wish markets and the economy had not grown so incredibly dependent on easy money, but it’s just the way it is, thanks to the Fed. We think it will have to abandon its balance sheet reduction efforts because circumstances will dictate such as economic prospects deteriorate. We also have a hard time believing that the ECB will be able to discontinue QE next year for long. China will likely feel compelled to open the fiscal taps again soon.
The problem going forward is that most marginal projects, business ideas, or purchases by consumers have likely been done already because of ten years of easy money policies. The most marginal of these would have never been done in a sounder money environment. Huge increases in debt made them possible. We have said it many times. Debt is simply demand brought forward.
Everyone wants to blame tariffs or other news items for increased volatility, but we think that it mostly comes down to the reversal of monetary policy. For now, the S&P 500 refuses to re-price as much as many securities and other asset classes that have become inexpensive in comparison. We expect investors to slowly fall out of love with recent market darlings as they realize that recent highs may not be revisited for quite some time, perhaps years, and maybe never, much like the 2001-02 period played out.
For much of the last few years, investors refused to cease euphoric speculation that went well beyond that of cycles past. However, this year ultimately proved to be the toughest in about fifty years to find asset classes that have made money according to Ned Davis Research. Call it the downside of years of money printing and bubble economics.
The views expressed on this blog are the opinions of the authors. This information is not intended as investment advice or to recommend the purchase or sale of securities. More information on Strategic Balance, LLC may be obtained by contacting investor relations.