Will Wall Street Lose Faith in the Fed?

The Federal Reserve gave Wall Street just about everything it wanted, helping to make the first three months of 2019 a great time to be in stocks and bonds.

Yet Fed policy may be partly responsible for problems in the markets, too, raising the prospect of a reversal later this year.

For the quarter, the average domestic stock fund tracked by Morningstar gained 13.5 percent, led by specialists in technology, energy and consumer issues. Bond funds were up 3.8 percent, and international stocks rose 11.1 percent, with funds that focus on China and other emerging markets doing best.

But some market strategists worry that the Fed has been trying too hard to please investors.

“Central banks feel pressure to act when they should do nothing,” said Luca Paolini, chief strategist at Pictet Asset Management. “That’s a terrible message: ‘Don’t worry because we’ll be there for you.’”

The Fed abruptly signaled, just as 2019 began, that it was shifting to an easier monetary policy when there were unmistakable signs that economic growth was flagging. The Fed’s benign message sent stocks to the best January in more than 30 years after the worst December in nearly a century.

But when the central bank reiterated its relaxed posture last month, promising not to raise interest rates this year, the reaction in the stock market was less enthusiastic, and bond yields sank, a sign of concern about economic prospects.

Traders who keep faith with the Fed may feel vindicated by its decision to move in a dovish direction and no doubt will continue to support share prices.

But the Fed has come under pressure from President Trump to be more dovish still. And some investment advisers detect a whiff of desperation in the Fed’s efforts to keep the economic recovery and bull market going into their second decade. They question how long either can continue before a painful reckoning.

Mutual Funds

Highlights of mutual fund performance in the first quarter.



anastasios pallis

Leaders and Laggards

Stocks vs. Bonds

Among general domestic stock funds.

Average returns, by fund category.

General stock funds

6.0

3.3

3.2

4.6

13.6

11.1

3.8

2.6

Alger Smid

Cap Focus

+

+

+

+

+

+

+

22.0

27.3

21.5

22.2

25.5

25.0

14.5

31.0

+

+

+

+

+

+

+

+

30.6

30.6

28.0

27.9

27.8

27.1

27.1

26.5

International stocks

Morgan Stanley

Inst. Incept.

Taxable bonds

Leland Thomps.

Reut. Vent. Cap.

Municipal bonds

Eventide

Gilead

Growth vs. Value

Neub. Berman

Sm. Cap Gr.

Returns in the first quarter.

Lord Abbett

Dev. Growth

Hodges

Retail

Morgan Stanley

Inst. Disc.

Sector by Sector

Convergence

Core Plus Inst.

+

+

+

2.1

2.2

n/a

2.0

1.4

3.9

0.4

27.3

+

+

+

+

+

+

+

3.8

3.7

3.5

2.9

2.1

0.6

0.0

6.6

Meeder Mod.

Alloc. Inst.

Technology

+

+

+

+

+

+

+

11.0

1.9

16.9

5.1

13.1

7.3

6.5

16.8

8.0

3.2

+

+

+

+

+

+

+

+

+

+

20.9

16.4

16.1

15.5

13.4

13.4

12.5

11.4

8.8

0.8

Equity energy

Trend Aggreg. Div.

and Inc. Inst.

Real estate

Copeland Risk

Man. Div.

Consumer defensive

Intrepid Endur.

Investor

Communications

Power Div.

Index

Natural resources

Redwood Alpha

Tact. Core

Multicurrency

anastasios pallis

Stocks vs. Bonds

Average returns, by fund category.

General stock funds

6.0

3.3

3.2

4.6

13.6

11.1

3.8

2.6

International stocks

Taxable bonds

Municipal bonds

Growth vs. Value

Returns in the first quarter.

Sector by Sector

Technology

+

+

+

+

+

+

+

11.0

1.9

16.9

5.1

13.1

7.3

6.5

16.8

8.0

3.2

+

+

+

+

+

+

+

+

+

+

20.9

16.4

16.1

15.5

13.4

13.4

12.5

11.4

8.8

0.8

Equity energy

Real estate

Consumer defensive

Communications

Natural resources

Multicurrency

Leaders and Laggards

Among general domestic stock funds.

Alger Smid

Cap Focus

+

+

+

+

+

+

+

22.0

27.3

21.5

22.2

25.5

25.0

14.5

31.0

+

+

+

+

+

+

+

+

30.6

30.6

28.0

27.9

27.8

27.1

27.1

26.5

Morgan Stanley

Inst. Incept.

Leland Thomps.

Reut. Vent. Cap.

Eventide

Gilead

Neub. Berman

Sm. Cap Gr.

Lord Abbett

Dev. Growth

Hodges

Retail

Morgan Stanley

Inst. Disc.

Convergence

Core Plus Inst.

+

+

+

2.1

2.2

n/a

2.0

1.4

3.9

0.4

27.3

+

+

+

+

+

+

+

3.8

3.7

3.5

2.9

2.1

0.6

0.0

6.6

Meeder Mod.

Alloc. Inst.

Trend Aggreg. Div.

and Inc. Inst.

Copeland Risk

Man. Div.

Intrepid Endur.

Investor

Power Div.

Index

Redwood Alpha

Tact. Core

By The New York Times | Source: Morningstar

“They screwed up badly by making us worry they’re out of bullets,” said James Paulsen, chief investment strategist at the Leuthold Group. “You don’t say you’re going to guarantee no rate hikes until 2020. What are they so scared about all of a sudden?”

The short answer: a recession.

By one important measure, the economy is doing nicely; the unemployment rate was 3.8 percent in March, close to a 50-year low. But that tends to be a lagging indicator, as employers are reluctant to let workers go until they have no choice. Much other data, related to factors as diverse as housing, borrowing, consumer confidence and manufacturing, hints that the decade-long economic expansion may be in jeopardy.

The stock market was happy to put its faith in the Fed’s renewed commitment to buoy the economy through most of the first quarter; even after losing a bit of ground in the final week or so, the S&P 500 rose 13.1 percent. But bond traders seem unconvinced.

The yield on 10-year Treasury issues sank from about 3.2 percent in October to 2.44 percent on March 22, less than the 2.45 percent rate on three-month Treasury bills. That condition, an inverted yield curve, didn’t last long. The 10-year rate on Thursday was 2.5 percent; the three-month rate, 2.36 percent. But the brief inversion suggested that investors were anticipating slow growth for a long time, dovish Fed or not.

Although the extent of the Fed’s ability to influence the markets is open to debate — the changes it makes to the interest rates it sets tend to follow changes in market rates — Komal Sri-Kumar, president of Sri-Kumar Global Strategies, said the Fed could support the stock market if other factors, such as valuations, cooperated.

“If it’s very overvalued and the Fed cuts rates to help, it’s not going to prevent a correction,” he said.

Mr. Sri-Kumar expects the Fed to reduce interest rates in June and September. Valuations are reasonable enough, in his opinion, that “the Fed has a chance” of propping up stocks, but if it continues to cut after that or begin a new round of asset purchases, even with stocks doing well, it may prove counterproductive.

“The Fed is going to help the stock market for some time, but by the end of 2019, it will run out of options,” he said. “If valuations are much higher than today and the Fed says it’s going to keep the rally going, then people will say, ‘The Fed probably knows something about the economy, so I’ll sell.’”

What everyone seems to believe about the economy is that it’s on less stable footing than last year.

Image
Jerome Powell, chairman of the Federal Reserve, speaking after the Federal Open Market Committee met March 20. The Fed predicted that it would not raise rates this year.CreditAl Drago for The New York Times

The Baltic Dry Index, which measures the cost of carrying bulk goods by ship, plunged more than 30 percent in nine months, to a three-year low. Defaults on loans to American farmers recently hit a nine-year high, and a record number of car loans are 90 days past due.

The economic picture abroad is worrisome, too. Growth in China has subsided as frosty trade relations with the United States linger. As uncertainties remained over exactly how Britain would detach itself from the European Union, the Bank of England last month reported reductions in growth in construction and retail sales, and a decline in manufacturing output. German industrial orders just recorded their biggest year-on-year drop since 2009, raising recession fears there.

The slowing growth is filtering through to corporate earnings. The companies in the S&P 500 are estimated to have made 4.1 percent less in the first quarter than in the first quarter of 2018, according to FactSet Research. The firm foresees a modest pickup for the full year to 3.6 percent growth.

For many market professionals, it’s a question of when, not if, the economic and earnings backdrops become too feeble and stocks suffer another fall.

Tobias Levkovich, chief United States equity strategist at Citi Research, says the clock is ticking.

“If the Fed’s not going to raise rates tomorrow, that’s fine,” he said, “but there’s a sense that this is the end of the cycle.”

The Fed’s about-face “was a very powerful buy signal” and a “major reset of expectations,” Mr. Levkovich said, but manufacturing has looked weak for several months, based on orders for durable goods, surveys of purchasing managers and German exports to China.

Another concern is surveys indicating more rigorous standards on commercial and industrial loans, which “tightened up sharply in the fourth quarter,” he said. Changes in lending standards tend to be felt in the economy about nine months later, he noted, so “late in the third quarter or in the fourth, we’re likely to see some softening up of economic data and earnings.”

Mr. Levkovich expects the S&P 500 to end the year at 2,850, near where it is now, and it could reach 2,950 before easing. Until then, economically sensitive areas that weakened as growth slowed, such as energy, semiconductors and capital goods, could outperform, he said, and if you’re looking for something safer as a hedge, try big pharmaceutical companies.

The New York Stock Exchange. The Federal Reserve’s policies helped the stock and bond markets to a strong first quarter.CreditGabby Jones for The New York Times

Ian Mortimer, co-manager of the Guinness Atkinson Global Innovators fund, also likes semiconductors, one of several technology niches that he expects to grow even in an iffy economy, including payments and e-commerce. These tech segments can capitalize on the expansion of data centers and the development of artificial intelligence and the internet of things, or the use of internet connections to enhance the use of everyday, real-world objects.

“These secular-growth themes continue to grow regardless of what the market is doing,” he said. By contrast, “older industries are feeling pressures.”

Mr. Paolini at Pictet called the first-quarter rally “an overreaction to an overreaction” and warned that “the next big move is going to be down, not up.” But while he sees “lots of headwinds” preventing the market from rising in the short term, he added, “I don’t see a clear catalyst for a significant decline.”

He finds more opportunities overseas. American defensive stocks may be expensive, for instance, but a higher proportion of British stocks are in defensive sectors, and they are much cheaper, he said. When signs of a recovery in global growth appear, he would put more money into Continental Europe, where economically sensitive stocks are reasonably priced, and Japan.

Mr. Paulsen expressed concern about the yield curve, but he saw few other harbingers of recession. Household debt is well behaved, and the leading indicators index, a basket of economic measures that tend to move ahead of changes in economic growth, is at a record high.

The sharp decline in bond yields and the correction last year have taken the backdrop for stocks “from hostile to hospitable,” he said. He also noted that sentiment is “so bearish and cautious,” which often occurs closer to bottoms in stocks than tops.

He’s not bearish, but he is cautious. Whatever an investor’s neutral allocation to stocks would be, he recommends committing slightly more, particularly in foreign markets and in economically sensitive niches like energy, basic materials and industrials.

As important a signal as the inverted yield curve may be, Mr. Paulsen suggested that it might be sending a false signal because it has occurred under the unorthodox practices and unique conditions engineered by the Fed after the financial crisis a decade ago. He wouldn’t bet much on the economic expansion or the bull market persisting, but he wouldn’t bet much against it, either.

“I like the odds that we’re overestimating risks, but that’s not to say it’s not the start of 2008 again,” he said. “Everything about the Fed has been weird in this cycle. If this has the weirdest ending, it shouldn’t shock us, but that doesn’t necessarily mean a bear market. What if we had another five years of recovery? There are a lot of different weird ways this could go.”

This article is from NYT – go to source

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