Weekly Update 12/21/2018: The Grinch Who Stole Christmas, the Chairman Powell Story
by Zach Marsh on Dec 21, 2018
S&P 500 -7.07%
10 Year Treasury +0.85%
Weekly Update: The Grinch Who Stole Christmas, the Chairman Powell Story
Last week we discussed the importance of this week’s Federal Reserve announcement on interest rate policy. On Wednesday we got the announcement, and while the Fed did not fail to deliver on the drama, it did fail to deliver. In what can be described as one of the most contentious years in Washington, Chairman Powell decided it was his turn to get involved. And while this week, former National Security Advisor, General Michael Flynn was called a traitor by the judge presiding over his sentencing; a strong case could be made that Chairman Powell the one guiltier of treason. Ok, maybe just dereliction of duty.
For only the third time since 1980 the Federal Reserve raised interest rates at a time when the stock market was down over the most recent 3, 6, and 12 month periods. In 1980, Chairman Paul Volker raised rates during a period of negative stock market returns, but inflation was north of 10%--today our inflation rate is hovering near 2%. Powell raised rates despite the fact that, in his own words, “Inflation has continued to surprise to the downside.” Needless to say the market was less than thrilled with his actions. From the time of his announcement, at 1pm Wednesday, until the close of business today, the S&P 500 has fallen nearly 6%. The market reaction to Powell’s decision exposed the real culprit behind the market sell off which began on October 3rd; more than trade policy, the cause of the current market turmoil is the persistence of the US central bank to continue raising interest rates.
The Chairman has refused to pause his rate hiking crusade long enough to see what the overall economic impact of his previous 8 hikes will be. He speaks of the strength of the US economy as an outlier of economic strength around the world yet fails to take note that the worst performing domestic stock markets this year are the small capitalization indices. Small companies, contrary to large multi-nationals, are more reliant on a strong domestic market to drive growth. Additionally, small cap stocks carry more debt, and are thus more exposed to higher borrowing costs. Stock markets, while not perfect predictors, are forward looking. The 25.5% decline in the Russell 2000 Small-Cap Index since August is certainly a canary in the coal mine that Powell should consider.
While some argue that the Fed is not responsible for the stock market--rather its mandate should be the US economy as a whole. However, if the economy is its mandate, then the rate hike seems even more baffling. An economy growing at roughly 3%, with inflation around 2%, hardly seems like an economy in the midst of overheating. More troubling is the fact that only recently have wages begun to creep higher—this, after years of stagnant wage growth. Raising rates will only serve to stifle that progress in the long run.
Powell made one thing abundantly clear Wednesday, the market should not rely on the Fed to bail it out anytime soon. The S&P 500, down nearly 11% this month, is on track for its worst December since inception in 1950. Only the 6% decline in December 2002 comes anywhere close to equaling this fall. In addition, the market is also on pace to crack the top 10 in terms of worst months since 1950. Without a doubt nearly all of this turmoil can be placed at the feet of Chairman Powell. The Fed likes to believe that it is capable of steering the US economy, bringing it gently in for landing, but more and more we are forced to acknowledge that a toddler has a better chance of landing a 747 than the Fed does of landing the US economy.
For a current tally of where the major market indices sit in relation to their all-time highs:
Dow Jones Industrial Average -16.14% S&P 500 -17.34%
Nasdaq Composite -21.37% Russell 2000 -25.5%
Finally, David and I would like to wish all of you a Happy Holiday Season. We hope that for your upcoming week you will be surrounded by friends and family. And we hope that 2019 will be brighter.
Thanks for reading,
Zach and Dave
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