Investors were pleased with the Federal Reserve’s (Fed) new approach to its balance sheet.
The Fed delivered its semi-annual Monetary Policy Report to Congress last week. The report recapped the events of late 2018 and reiterated the Fed’s intention to “…be patient as it determines what future adjustments to the federal funds rate may be appropriate to support the Committee's congressionally mandated objectives of maximum employment and price stability.”1
In other words, rate hikes are on hold for now.
The Fed also addressed issues related to its balance sheet, which grew from $900 billion at the end of 2006 – about 6 percent of the United States’ gross domestic product (GDP) – to almost $4.5 trillion at the end of 2014 – about 25 percent of U.S. GDP. (GDP is the value of all goods and services produced in the United States in a given period.)2, 3
The balance sheet more than quadrupled during the past decade because the Fed began buying Treasuries and mortgage-backed securities, a policy called quantitative easing, in an effort to restore the U.S. economy to health, according to The Hutchins Center of the Brookings Institute.4
Friday’s report indicated the Fed will not shrink its balance sheet to pre-crisis levels, reported Erwida Maulia for Financial Times. Markets responded positively to the news:5
“U.S. stocks and Treasuries were comfortably higher at midday on Friday as the Federal Reserve signaled it will hold a much larger balance sheet in the long term than it did before the financial crisis, helping ease investor concerns about tightening financial conditions.”
Investors also remained optimistic about trade talks between the United States and China. Major U.S. stock indices finished the week higher.6
Why did the stock market do that?
The great mystery of stock markets reared its head last week. With no clear driver, the Dow Jones Industrial Average gained more than 3 percent, while the Nasdaq Composite and Standard & Poor’s (S&P) 500 Index moved higher by about 2.5 percent. It was a puzzler. Ben Levisohn of Barron’s explained:
“Given those gains, we’d expect a heaping helping of good news, but not much was forthcoming. Earnings reports from [two large multinational companies] left investors wanting. And economic data were either bad or terrible in the United States – industrial production declined in January, the first drop in eight months, while December’s retail sales fell the most for any month since 2009. But who needs good news when the United States and China are reportedly making progress on trade talks? Yes, the details remain a little fuzzy, but at least the tone is more constructive.”
It probably wasn’t just optimism about China that pushed markets higher. Consumer Sentiment, which gauges Americans expectations for the economy, was up more than 4 percent month-to-month. One driver of consumer optimism was relief the government shutdown had ended. Another driver is a change in inflation expectations, which are at the lowest level seen in half a century. Americans think inflation will remain low and they anticipate wages will rise. The Federal Reserve’s newly accommodative attitude hasn’t hurt, either.
Investor sentiment was leaning bullish last week, too. Willie Delwiche of See It Market reported the Investor Intelligence survey of financial advisors showed 49 percent bullish and 21 percent bearish. The AAII Investor Sentiment Survey reported bulls (40 percent) edged bears (37 percent) by a neck. Those indicators were balanced by the Daily Trading Sentiment Composite from Ned Davis Research which suggested optimism was too high.
When markets rise, as they have during the past few weeks, it may be tempting to take a more aggressive stance and tilt your portfolio toward U.S. stocks. This may not be a good idea.
Central banks take a turn.
At its first policy meeting of 2019, the U.S. Federal Reserve changed direction. After four rate increases in 2018, Chair Jerome Powell announced interest rates were on hold. Last week, banks in the United Kingdom, Australia, and India followed suit by either reducing rates or cautioning rate reductions were likely, reported Sam Fleming and Jamie Smyth of Financial Times.
The dovish tone of central banks owes much to slowing global growth. January’s International Monetary Fund World Economic Outlook lowered global growth estimates for 2019 and 2020. Changing expectations were fueled both by factors that slowed momentum in the second half of 2018 and by issues that pose a potential risk to continued economic growth. These included:
These issues have had limited effect on the U.S. economy; however, global risks are affecting the performance of some U.S. companies. Financial Times explained:
“The U.S. domestic economy has continued to put in a robust performance, with the number of new jobs in January coming in well ahead of Wall Street expectations and wage growth running comfortably above inflation. But corporate giants in the S&P 500 index, which generate over a third of their earnings overseas, are sounding the alarm about faltering overseas demand in markets including China, where the government has been battling against a slowdown. Smaller U.S. firms are feeling the global chill as well.”
Randall Forsyth at Barron’s reported major U.S. benchmarks finished last week higher, while the yield on 10-year U.S. Treasuries hit a 13-month low. Outside the United States, some global stock markets moved lower.
And, U.S. stock markets celebrated.
Last week, the Federal Reserve put itself on hold. The Federal Open Market Committee met on Wednesday, January 30, 2019, to discuss the state of the economy and determine policy. After the meeting, Fed Chair Jerome Powell offered a positive assessment of U.S. economic strength that was leavened with a few concerns.
“We continue to expect that the American economy will grow at a solid pace in 2019, although likely slower than the very strong pace of 2018…Despite this positive outlook…Growth has slowed in some major foreign economies, particularly China and Europe. There is elevated uncertainty around several unresolved government policy issues, including Brexit, ongoing trade negotiations, and the effects from the partial government shutdown in the United States…We are now facing a somewhat contradictory picture of generally strong U.S. macroeconomic performance, alongside growing evidence of cross-currents. At such times, common sense risk management suggests patiently awaiting greater clarity…”
The Standard & Poor’s 500 Index (S&P 500) welcomed the news and delivered its best January performance since 1987, reported Reuters.
Earnings may have helped. Through the end of last week, almost one-half of companies in the S&P 500 had shared fourth quarter 2018 earnings. FactSet reported the blended year-over-year earnings growth – which includes earnings for companies that have reported and earnings estimates for companies that have not yet reported – was 12.4 percent. That’s lower than the 20-plus percent growth companies have delivered since late 2017, and it’s the fifth straight quarter of double-digit earnings growth.
There was good news to close the week, too. The Bureau of Labor Statistics reported far more jobs were created in January than analysts had anticipated, although unemployment ticked higher for the month because of the government shutdown, reported Bloomberg.