'Tis The Season
We’d like to start by wishing all of you a belated Happy Chanukah and a very Merry Christmas. Here at GreenPort we will also be celebrating Festivus, the annual airing of grievances. Ours is the Fed. 2018’s last full week of trading starts today. It will be an interesting week. The Fed meets on Tuesday and Wednesday, and will follow up their Wednesday meeting with a press conference. Wall Street traders will be watching closely. While the pundits have discussed many reasons for the recent market sell-off, the most frequently mentioned is the Federal Reserve’s aggressive tightening of monetary policy. We agree. China trade disputes, disfunction in the European Union, geopolitical uncertainty, etc. all factor into the market’s movements, however the Fed will ultimately decide the direction of this market. The Fed has raised short-term rates 8 times in the last 2 years, moving the Fed Funds Rate from .25% to 2.25%. Following the 2008 credit crisis, the Fed adopted a zero interest rate policy (ZIRP) in hopes of sparing the economy from economic ruin. The unprecedented rate cut was successful in achieving its purpose and financial Armageddon was avoided. As they economy improved rates were left at these historically low levels, not gradually increased as would be expected. New Fed Chair Powell believes the prior Fed was wrong not to raise rates under Janet Yellen’s leadership. He has decided to aggressively move rates higher and has slowed the economy under the delusion that he must control inflation. The market is hoping Chairmen Powell will signal a pause to rate hikes. If he does, we will avoid a recession and markets will move higher. If he doesn’t, it’s time to lower our equity exposure.
Fed policy directly and immediately impacts the economy. When short term interest rates rise, companies pay more to finance their operations. This higher cost of debt lowers margins and decreases earnings. Stock investors buy the future earnings of companies, so when earnings decrease, investors will demand to pay less for those earnings and stock prices will decline. Consumers are also impacted by higher interest rates. The higher the cost of debt, the less they can borrow. The less the borrow, the less they spend. The less they spend, the less companies earn. The less companies earn, the more stock prices go down. Higher short-term rates lower both corporate and consumer lending by banks and other financial institutions. There are two reasons for this. The first reason is higher rates lower money supply by requiring banks to maintain higher reserves. The second reason is raising short-term rates “flattens” the yield curve which is bad for banks. Bank lending is based on banks borrowing at short-term rates and lending at long-term rates. An example would be a mortgage. Banks lend money to a homebuyer for a mortgage at the long-term rate (banks collect interest at this rate), and finance that loan through consumer CD’s, savings and checking accounts held at the bank (banks pay interest at this short-term rate). When short rates are low and the yield curve is “steep”, banks make money paying the low rate and collecting the high rate. Now that short rates and long rates are similar due to the Fed raising short-rates, lending is less profitable, so lending declines. It’s not too late for the Fed to stop raising and avert a recession. Consensus earnings are still growing but forecasted earnings for 2019 and 2020 are flattening out.
We still believe this latest sell-off is yet another correction within the secular Bull Market. However, if the Fed doesn’t signal a pause for 2019 we will lower our long range stock forecast and stock allocation. There have been many temporary setbacks since the initial 2008 decline. Since the 2009 low, stock market indices in the U.S. are up around 400%.
Which brings us back to Festivus and the annual airing of our grievances. Once again, as in prior corrections during this bull market, the perma-bears are informing investors, “we told you so”. It seems to us that a 12% loss within a 400% gain is still a better than missing out on the 400% gain? We will leave you with this Warren Buffet quote, “the stock market is designed to transfer money from the active to the patient”. Have a Great Week, The GreenPort Team