We live in unprecedented times. At least it seems so considering how short our memories are. It seems unprecedented how quickly the Fed has turned dovish from hawkish in just a matter of weeks.
After hiking rates in December, the Fed has gone increasingly dovish in order to either satisfy the markets, President Trump or the slowing economy. Perhaps a combination of the three. Regardless, the Fed only got 2.5% before it’s essentially signaled that it’s done.
Typically (what’s typical anymore?) the Fed would like to get rates higher before heading into another recession so that it has more ammunition to fire at an oncoming recession. Welp, 2.5% will have to do it seems.
And you’ve got Trump himself and Trump’s inner circles making calls for immediate cuts to the rates already. Quite a turn.
So, the common knowledge is that a dovish Fed equals higher asset prices, and this is true to a degree at least at the surface level. But the dirty little secret is that the Fed was cutting rates before the market crash in 2008.
Fed cuts can swing both ways in terms of market reactions. Yes, Fed rate cuts can make the market rally. It can also move the market in the other way by essentially confirming our fears of a slowing economy. This is likely at least partially what occurred in 2008.
The market is forward looking, and so is the Fed. Remember, GDP was negative for much of 2009, but the market had already bottomed early in 2009. GDP was positive in 2008 when the market tanked. Both the Fed and the market aim to get out in front of a slowing economy. And we definitely have a slowing economy right now.
The economy peaked growth-wise in 2018. The Fed has confirmed the economic slow down via its actions and its rhetoric. So while stocks continue to go higher and get closer back to its all-time high, I’m remaining defensive and not buying in. That said, I’m long sectors that are highly sensitive to a dovish Fed such as gold and energy. I’ve got small long positions in XLE (energy ETF) and GDX (gold miners ETF).
It’s also worth noting that oil spiked to $150 back in July 2008 after the stock market had already peaked and just before everything crashed. The Fed began cutting rates in September 2007 (from 5.25%). Oil was about $83/barrel. By July of 2008, oil was near $150 and the Fed rate was at 2%.
I don’t anticipate anything near a 2008-like crash unless there’s a significant debt market event (corporate debt levels, to me, are the one Black Swan potentially on the horizon).
2019 should be an interesting year. It’s not a bad thing to lock in the gains already booked.