The fourth quarter of 2018 has so far delivered losses to investors, with the S&P 500 dropping close to 15% since October 1, and the MSCI EAFE Index (representing markets abroad) falling roughly 13% over the same period. Concerned investors looked to governments—and especially central banks—to help calm their fears of a weakening market, as these entities had done so in the past. The Federal Reserve meeting on December 19 was considered significant regarding this point, as the monetary policy of the United States directly and indirectly impacts the economies of many nations abroad.
What Happened at the December 19 Meeting?
As December 19 approached, market participants were hoping the Federal Reserve would see various data points such as the stock market declines, slumping home sales (largely due to higher mortgage rates), and moderating economic growth as enough evidence to not raise interest rates in December. If not that, market consensus seemed as though investors would be accepting of an interest-rate increase followed by commentary on delaying some further increases. Neither of these scenarios occurred, and the Federal Reserve increased interest rates and offered generally little guidance regarding putting off further increases in 2019. The market reaction to this was negative, causing the major market indexes to fall to new multi-month lows.
One of the core philosophies of macroeconomics is that small adjustments in monetary policy (i.e., interest rates) can produce major effects in an economy. Investors are not concerned about rising interest rates alone so much as they are that the Federal Reserve will increase rates at a pace the economy cannot support. There are tools we employ to determine if this is occurring. Among these include various financial conditions indexes, leading economic indicators, yield curve data, and supply-chain data. And, while some of these metrics suggest some potential economic headwinds, none currently suggest the Federal Reserve is making a policy error that could lead to an economic downturn.
Furthermore, despite what the Federal Reserve may project, we don’t believe rates will increase much more throughout 2019. The futures market agrees with this statement, implying a 52% chance that the federal funds rate will be unchanged by the end of next year versus where it stands today.
What This Means for Portfolios:
We currently view the recent decline as a normal correction within an ongoing bull market. We do believe that there will be a shift in leadership next year from “hot” growth stocks into more conservative issues, and we are fine-tuning portfolios to take advantage of this. Otherwise, with our data-driven approach not warning of a recession developing over the near term, we generally view any major asset reallocations unwarranted at this point.