There is a certain craziness in the stock market now, an irrational fear to paraphrase former Fed Chairman, Alan Greenspan. We don’t want to sugar coat it, but we’d like to try to explain it, and provide some tactical advice.
To understand the market, we have to look at two major components of performance in the short run: 1) the economic forecast, and 2) anticipation of what the Fed is going to do.
The first is fairly easy right now. Every economic indicator we see suggests continued growth (even strong growth) in the US economy. There may be a mild recession budding in Europe, but it would be mild and would only serve to pull a few tenths of a decimal point off our growth. If we look at the key statistics of actual economic activity (not sentiment or surveys, but actual physical, economic activity), here’s what we see:
Industrial Production – continued strength
Transportation Services – continued strength; stuff is getting shipped to customers (who are ordering)
Truck Tonnage Vs. Equities – a strange comparison, we admit, but this is a great indicator of how the mood of the market has diverged from the actual physical activity taking place. Clearly, the market is “spooked,” but certainly it can’t be spooked by what’s happening in the real economy.
So, what’s going on? This leads us to the second component; anticipating what the Fed is going to do. Scott Grannis (retired head economist for Western Asset Management and author of the charts above) once compared the interaction between the Fed and stock market to “a complicated dance, where one leads the other, and vice versa.” That is a great analogy. The market is trying to determine where the economy is going (up, down sideways), but the market is also trying to figure out where the Fed thinks the market is going. When both are in the same direction, there is little confusion. When they are not in the same direction, there is a lot of confusion and second-guessing.
In our humble opinion, the Fed just stepped on its dance partner’s feet – both of them in fact. Chairman Powell’s actual comments indicated that the Fed is revising its economic forecast from 3.1% growth in 2018 to 3.0% (a ridiculous difference to even debate), and revising its economic forecast for 2019 from 2.5% to 2.3% (again, somewhat insignificant). Were that the extent of the comments, we wouldn’t be experiencing an emotional sell-off.
Unfortunately, the Fed Chairman went on to say that the Fed is going to be a bit more restrained in interest rate hikes, yet they are going to keep scaling back the quantitative easing because they are on “auto-pilot.”
This gets a little confusing, so please bear with us. If the economy is healthy, the market should expect the Fed to continue raising interest rates. In this sense, interest rate increases are a good thing – they communicate strength. But if the Fed says they’re going to slow down, the natural question is why? Is there a problem?
But at the same time, the Fed says they will continue to unwind quantitative easing and its “on auto-pilot.” That is a good thing and communicates the Fed believes there is sufficient strength in the market to allow for the excess liquidity to be removed.
Hopefully, you can see that these statements are contradictory and introduce more uncertainty than they do anything else. THIS is the dance used in the analogy. The Fed’s communications are muddled. Given the craziness in the world right now, it’s easy for a sense of irrational fear to set in, and that’s exactly what we see. This is not a harbinger of a recession; the market has excessively sold off and should recover within a reasonable time.
The problem is predicting the timeframe for “irrationality.” How long can people ignore the economic numbers and their own experience (surveys indicated that vast majorities of Americans feel their economic situation has improved and is good)? We can’t answer that question, but we absolutely would not recommend that anyone sell off equities because of it. That would be the worst possible reaction.
For those with confidence in the long-term, and with a nuanced understanding of what’s going on here in the short-term, buying into equities at these depressed prices is a good strategy option.