ETF Store Insight

Fed Keeps the Party Going

July 11th, 2019 by Nathan Geraci

Nathan Geraci is President of The ETF Store, Inc. and host of ETF Prime.

Despite hitting a speed bump in May, U.S. stocks continued rolling along in the second quarter of 2019 and posted their best first half of a year since 1997.  The S&P 500’s 6%+ decline in May was fueled by concerns over an ongoing U.S.-China trade war and slowing global economy.  Those fears proved temporary with the Federal Reserve striking a dovish tone in June, providing a confidence boost to investors wondering how much longer the current bull market run can last.  The S&P 500 gained 7% in June – its best June since 1955 – quickly reversing May’s drop as U.S. stocks closed the second quarter up 4%+.

Investor sentiment continues hinging on every Fed-uttered word.  The market expects a Fed rate cut later in July, with additional cuts coming over the next year.  The swiftness with which market rate expectations have changed since October 2018 is staggering.

 

You may recall at the Fed’s December policy meeting, they projected two additional rate hikes in 2019.  The Fed then abruptly reversed course in January, causing market participants to quickly adjust their rate expectations as depicted in the above chart.  Last quarter, with the Fed turning decisively dovish, we offered the following commentary:

“There’s an old market adage, ‘don’t fight the Fed’.  Basically, when the Fed takes an accommodative stance, investors should go along for the ride.”

The Fed continues to message a seemingly unending willingness to support the economy and financial markets.  On the backs of the Fed and other central banks around the world, nearly every major asset class is positive for the year, with global stocks posting double-digit returns and lower rate expectations propelling bonds (whose prices move in the opposite direction of interest rates).

In a 1955 speech, then Fed Chairman William McChesney Martin described the Fed’s job as a “chaperone who has ordered the punch bowl removed just when the party was really warming up”.  In other words, a strong economy (think good party) is typically a sign that the Fed should consider raising rates (taking the punch bowl away).  One of the Fed’s key responsibilities is ensuring the economy doesn’t overheat (the party gets out of control!).  They want to prevent inflationary pressures from taking hold.  Clearly, the Fed believes the party is still a bit tame and so they are actually looking to spike the punch bowl right now.

So When Does the Party End?

It is obviously unrealistic to expect the party to last forever.  The stock market doesn’t go up in a straight line indefinitely and even the Fed – one of the most powerful institutions in the world – has a limited supply of punch.  The back half of last year reminded investors that risk is always present, with the S&P 500 declining 20% from September 20th to December 24th.  However, the bounce back in the first half of 2019 can have a way of quickly erasing any negative feelings investors experienced last year.  The party is still going after all and everyone wants to continue having fun!

While we believe in a longer-term optimistic view of the markets (and we certainly appreciate a good party), we know the current situation must end at some point.  As Bloomberg’s Eric Balchunas colorfully commented:

“How long can the Fed keep the party going?  It’s like the party feels like it’s four in the morning now and I know the Fed just brought some new beer, but it’s like dude – I got to get some sleep. This thing is going to bust up soon!”

The fourth quarter of last year provided a dry run for when the party ends.  How did you feel?  Have too much punch?  There’s no question the current party is the one to which every investor always wants an invitation.  Even better, the clock has not yet struck midnight.  That makes now the perfect time to assess how you felt during last year’s declines and think critically about your current and future financial goals.  It’s an excellent time to enjoy the party and be thankful for this year’s returns, but also think about how you’re going to get home once the party ends.  We are here to help.