Fed caution restrains stock market reaction to dovish announcements

Thursday, 21st March 2019 11:09 - by Shant

The stepdown by the Fed earlier this year went a long way to helping US stocks return to better ways after the rout seen in the last quarter of 2018.  The 20% slump in the major US indices has been all but recouped in a dramatic turnaround, which was helped in no small part due to the Fed's announcement that it will end the balance sheet runoff this year. 

Indeed, in Wednesday's policy announcement, the Fed specified its plans to halve the reinvestment cap from $30bln to $15bln from May and end it completely in September of this year.  This was perhaps the most dovish part of the Fed decision last night, though the focus was on the famed dot plot which maps out projections among Fed members.  

At the end of last year, the map showed expectations of 50bps of hikes through 2019 and despite this being moderated to just one through a series of rhetoric over the early part of the year by various Fed committee members, the move to staying unchanged through the year provided a surprise to markets, who are now starting to price in rate cuts from the end this year.  Prior to this, the rates market had already assumed the Fed would be sitting on its hands through 2019, so perhaps the response from some of the asset classes - such as the Dollar - was a little overdone.  

However, what was notable was the lack of material positive response from US equities, as investors now seem to be more considerate of the economic backdrop rather than liquidity and cheap money.  The Fed also revised its growth forecast for 2.3% to 2.1% and while this is not a major development in light of the global backdrop, it does highlight risks associated with the outlook.  

Looking at the composition of major movers in the indices, the standout losers were the banks.  In the Dow Jones, Goldman Sachs was down 3.4% while JPMorgan also lost out by a little over 2%.  Lower rates clearly squeeze margins, but with fears over loans starting to attract greater attention in the financial media, investors should keep a close eye in default rates also.  It is set to be a tough environment for banks going forward, with low rates and subdued lending set to test revenue targets significantly.  On the S&P 500, KeyCorp was down over 5% on the day, with Fifth Third, M&T Bank, and Citizens Financial group all losing over 4% at the close.  Bank of America was also down 3.4%, with Northern Trust and State Street down over 2.5%.  

Among the winners on the day, notable were utilities - proving resilient in cautious times.  Chesapeake Energy was up there, gaining over 3% on the day, outperformed by Noble Energy at up 3.5%.  Duke Energy which is double the market cap, rose a more modest 0.3%.  Schlumberger and Halliburton were also winners on the day due to higher Oil prices, with the benchmark WTI grade now testing $60.  Netflix, Alphabet, Amazon, and Facebook also sported 2%+ gains, with Netflix up over 4.5%.  

Needless to say, from here on out, stock pickers need to be ever more cautious, and I would underline the reliance of staples.  Banks and financials are looking extremely vulnerable.  European banks have been a popular sell amongst hedge fund managers, and with concerns over housing in both Australia and Canada, the respective financial institutions in these regions are also now attracting selling interest from asset managers.  Given that bank stocks have tended to front-run peaks and troughs in the business cycle, this is a clear sign that valuations will be seriously challenged in the weeks and months ahead. 

Gold started to shine once again - Dollar weakness helping last night. In recent weeks, we have seen the yellow metal testing below the $1300 mark, but holding firm in the $1275-80 region.  For a number of weeks now - if not more - I have been advocating a healthy addition of this key safe haven asset to portfolios, and nothing has changed my view.  Over the next few years, I envisage significant upside here, with investors looking to preserve a greater proportion of capital at the expense of yield and dividend-seeking. 

The Writer's views are their own, not a representation of London South East's. No advice is inferred or given. If you require financial advice, please seek an Independent Financial Adviser.