I’m getting a little tired of hearing the words “Fed” and “Powell” every time I turn on the financial news.
If U.S. politics has devolved into the cult of Donald Trump, then the U.S. financial system has become the cult of the Fed.
Not all cults end in mass suicide via poisoned Kool-Aid. But they most certainly do end in disappointment when the leader fails to deliver.
The trouble is, there’s a lot of uncertainty with the U.S. economic outlook that keeps bringing these buzzwords together.
Fed, Trump, Stocks
Last Wednesday, Powell announced a quarter point rate cut as a “precautionary move” to cushion against global slowdown and ongoing trade tensions. Then on Thursday, Trump tweeted out that there would be a new round of tariffs on $300 billion in Chinese goods, effective September 1. The tweet torpedoed fragile trade negotiations that had only recently been restarted.
Stocks saw their worst sell-off of the year in the days that followed.
It’s all playing out like some bad drama: the Fed makes an announcement, Trump takes to Twitter, the stocks fall.
And I have a feeling that at this point a lot of Fed followers are questioning their faith…
Consider last year in the stock market when the S&P 500 dropped like a rock in the fourth quarter…
Because the Fed was viewed as being unreasonably hawkish given what looked like a slowing economy. But the market recovered, hitting new highs in April as the Fed backed off and indicated it would pause rate hikes.
Then stocks skyrocketed in June when Fed Chairman Jerome Powell hinted that a rate cut might be in the cards. And it continued moving higher until last week.
Is Any of This Reasonable?
Looking at data back to 1989, Goldman Sachs reported that the S&P 500 was, on average, nearly 13% higher a year after the Fed started cutting rates. Barclays ran a similar study going back to 1974 and found that stocks were, on average, up 9.2% a year after the Fed’s first rate cut.
Now, to start, take those figures with a large grain of salt given the small number of samples. There have only been nine rate-cut cycles since 1974, and that’s really not a big enough sample size to draw meaningful conclusions.
Furthermore, in three of those nine cycles, the market was actually lower a year later.
But that’s not even the worst of it…
The fed was afraid of going into the next recession without any “bullets”. That’s why the fed was so aggressive in raising rates over the past three years. The Fed hoped to have more ammunition with which to fight the next recession by pushing rates relatively high,
Well, we don’t know with certainty when the next recession will hit. But it’s safe to say the Fed will be going into this gunfight with its ammo clip half empty.
After the tech bust in 2000, the Fed lowered rates a full 5.5% — from 6.5% down to 1%. And once the world as we knew it ended in 2008, the Fed dropped rates all the way to zero.
There is no possible way the Fed can lower rates by a comparable amount the next time around. At today’s levels, a drop of 2.25% would take us right back to zero.
Could rates go negative? Sure.
The European Central Bank’s benchmark rate is stuck at -0.4%, and the Bank of Japan is at -0.1%. But dropping rates by a comparable amount as the last two cycles would put the Fed Funds rate at -3% or lower. That would shatter all records.
And I’m certain it would be politically impossible to pull off. We’ll just have to wait and see if it comes to that…
The Market May Still Go Higher From Here
In fact, it might go a lot higher. If we really are seeing the spectacular blow off the top of the Fed bubble, there’s really no telling how high it goes. Bubbles are, by nature, irrational. Modelling something irrational is an exercise in futility. When the Fed is finally recognized as the emperor with no clothes, it’s not going to be pretty.
I look for high-yielding value opportunities that have been out of sync with the major indexes. Stocks that are under-owned and off the radar of most investors are favored. These are less likely to get beaten up in a bear market since the investors most likely to dump everything don’t own them.