After five straight weeks of gains, the troubled start to U.S. stocks is fading from memory as central banks have stepped in to assure investors that they will provide the support they feel is necessary to solve their country’s economic woes. Just last week, the Federal Reserve (i.e., the U.S. central bank) announced it would reduce the number of interest rate increases they anticipated making this year. This means lower lending rates for longer.
The Federal Reserve is now forecasting they will hike interest rates twice in 2016, instead of the previous estimate of four times. While the Federal Reserve has been overly optimistic about implementing rate hikes over the last four years, they seem determined to move rates higher, even if it is at a slower pace. Given the new forecast, it seems likely that the Federal Reserve will increase rates in June and December. According to the CME Group’s FedWatch tool, the odds of a rate hike occurring in June are currently at 38%, which is almost double the 20% probability from a month ago.
Like the response to most other central bank rate announcements, global stocks rallied on the news. Yet, the U.S. doesn’t need rates this low and hasn’t for a couple of years. The U.S. economy has been growing at a slow and steady pace with only the occasional cause of concern. Inflation has been low and unemployment has significantly improved over the last six years. Yet investors can’t seem to get enough central bank support.
Last week Dr. David Kelly, Chief Global Strategist at J.P. Morgan Funds, made a great comparison of Fed policy to the economy and markets. He likened all of this favorable fed policy to Dumbo’s feather. Recall in Disney’s classic animated movie how Timothy, Dumbo’s little mouse friend, convinced Dumbo that a magic feather could make him fly. However, it wasn’t the magic feather that gave Dumbo his gift of flight, it was his oversized ears.
For the U.S. economy and for global stocks, investors have been focused too much on Fed policy (i.e., Dumbo’s feather). In our view, stocks and the economy have been moving higher because more people are working, corporate profits have been rising over time and corporations have adopted shareholder friendly policies like dividend increases and share buybacks. Additionally, there has been a string of innovations that has changed the way we consume and how businesses operate. For example, think about all the opportunities smartphones, cloud storage, 3D printing and fracking have created over the past years and what efficiency (and revenue) many of these innovations have generated for businesses in the U.S. and abroad.
Central bank policy has helped in managing investor nerves. Here, the comparison to Dumbo’s feather is right on point. Favorable central bank policies gave investors the comfort they needed to stay with or return to stock and bond investments following the 2008-2009 swift market decline that still hangs on people’s minds. While events of that magnitude are infrequent, investors overestimate the probability of them happening again. Knowing that central banks are working to make economic conditions favorable gives investors the extra piece of mind that helps them stay invested. Fortunately, investors who have stuck with stocks have been well rewarded since 2009. Going forward, we hope investors learn this economy can fly on its own.