Stock Market Focus On Fed Is Misleading

In trader jargon, the recent stock sell-off (most of the month of May) which saw global equity markets down by about 6%, created a technically "over-sold" situation, so markets were ripe for a bounce-back (fun for the stock market "cheerleaders"). U.S. Federal Reserve Chairman Powell helped yesterday with a suggestion that he could respond with rate cuts if the economic outlook deteriorates (more fun for the cheerleaders).

So that has all the analysts running to check on the history of stock market returns after the Fed does cut rates in the face of economic slowing. Marketwatch has a story with a table provided by Barclays: the average and median response by the S&P 500 after a 12 month period was higher by about 7-9%. Most recently, however, the 2001 cut was followed by a 12 month drop of -11.2% and the 2007 cut was followed by a 12 month drop of -13.7%. 

Suffice it to say that, if the economy is deteriorating, corporate earnings will also likely be deteriorating and stock prices that rise on lower earnings because the Fed cut rates, is a recipe for disaster. The big question then will be: how much will the U.S. economy deteriorate?

Equity traders are placing their bets.

But we do not gamble with our own money and especially with our High Rock Private Client's money.

The World Bank weighed in on their expectations in their June 2019 Global Economic Prospects report yesterday and it has lowered its projections across the board: "Global growth in 2019 has been downgraded to 2.6%, .03% below previous forecasts, reflecting weaker-than expected international trade and investment..."

At the risk of falling into the behavioural trap of confirmation bias, our friend David Rosenberg suggests this morning that: "Well, one thing we know about yesterday's monster rally in equities, and sell-off in bonds was that they had little to do with anything real or fundamental". Obviously I agree with David, but there are plenty who see something else (stock market bulls and cheerleaders).

The bulls are, in my humble opinion, suffering from another behavioural bias, which is recency: when the Fed has added liquidity, as they did with QE post 2008, stock prices tended to rise and they now live by that mantra. Until it no longer works. Remember the Fed has been draining liquidity since 2016 with their balance sheet reduction, which is akin to quantitative tightening. In 2018, this reality came into play and the declining monetary base started to push volatility into the stock market: (monetary base in blue, S&P 500 in orange)

Certainly the Fed wants stock markets to remain calm and as they did in late December (rising stock markets do affect consumer confidence in a positive way and vice versa) are using their speeches to talk markets down from their volatile swings.

Unfortunately, it is a short-term band-aid on a more difficult prognosis and without actionable and quick follow-up, will only exacerbate the problem. i.e. The 'boy who cried wolf' syndrome.

So for those of us sitting on cash or near-cash at the moment, stocks are hardly looking like a place to offer good investing value. Volatility will bring opportunity and staying patient will likely end up being the smart move. In the interim, there are alternative asset classes worth looking into. High Rock private clients have exposure to them.