“The US Federal Reserve may be backtracking slightly, with its plan for two further interest rate increases of 0.25% for 2019 rather than three, but that is clearly not enough for share prices that are missing their fix of cheap money – especially as chair Jay Powell continues to sanction a reduction in Quantitative Easing of up to $50 billion a month,” says Russ Mould, AJ Bell investment director.
Source: US Federal Reserve; FRED – St. Louis Federal Reserve database
“A huge bull case for stock markets in the US and worldwide was the TINA mantra – ‘There Is No Alternative.’
“The problem now is that improved returns on cash and a US 10-year Government bond yield of 2.75% mean there are now more options on the table for investors, especially if they are naturally risk-averse or have had their fingers burned by riskier choices earlier this year.
“As borrowing becomes more expensive, and returns on cash improve, it can surely be no coincidence that investors are treating money with more respect and taking less risk in search of a return.
“Cryptocurrencies blew up in the first quarter of 2018, low volatility strategies in the second, emerging markets in the third and highly-valued technology and momentum stocks in the fourth. This is a classic late-cycle progression as investors move away from more peripheral areas and retreat to where they feel safer.
“This begs the question of where we go from here and lots still rests on central bank policy, in the form of interest rates and Quantitative Easing – or what is now Quantitative Tightening in the USA.
“With regard to interest rates, the Fed has now pushed through four one-quarter point rate hikes in 2018, to take its total to nine for this upcycle, which began in December 2015.
“Uncannily, nine is the average number of rate hikes that it has taken to puncture US stock market bull runs across the eight peaks in the S&P 500 since 1970. Although it must be said that the range of interest rate increases needed to stop American stocks in their tracks is a wide one. Investors must acknowledge the Government, corporate, consumer and student debts stand at record highs, so the US economy is bound to be more sensitive to even minor changes in borrowing costs. Interest rates will not need to return to past historic peaks to have an impact.
|
Date |
S&P 500 |
Fed funds rate |
Change in Fed Funds cycle |
Change in Fed Funds cycle |
|
|
peak level |
at S&P peak |
before |
before S&P 500 peak |
|
11-Jan-73 |
120 |
5.50% |
3.50% to 5.50% |
2.00% |
|
21-Sep-76 |
1,008 |
5.50% |
4.75% to 5.50% |
0.75% |
|
28-Nov-80 |
141 |
15.00% |
4.75% to 15.00% |
10.25% |
|
10-Oct-83 |
173 |
9.38% |
8.50% to 9.38% |
0.88% |
|
25-Aug-87 |
337 |
6.63% |
5.88% to 6.75% |
0.88% |
|
16-Jul-90 |
369 |
8.00% |
9.81% to 8.00% |
(1.81%) |
|
24-Mar-00 |
1,527 |
6.00% |
4.75% to 6.00% |
1.25% |
|
09-Oct-07 |
1,565 |
4.75% |
1.00% to 4.25% |
3.25% |
|
|
|
|
|
|
|
Average |
|
7.59% |
|
2.18% |
|
Average excl. 1990 |
|
|
|
2.75% |
|
|
|
|
|
|
|
Current Fed rate cycle |
||||
|
16-Dec-15 |
? |
? |
0.25% to 2.50% |
2.25% |
Source: Refinitiv data, US Federal Reserve
“Globally, the withdrawal of QE could prove even more potent – especially as the Bank of England and European Central Bank have both stopped adding to QE and the Bank of Japan is undershooting its annual ¥80 trillion (£565 billion) target by some distance. Only the Swiss National Bank is still pressing ahead full tilt but it is the smallest of the five major monetary authorities to experiment with QE.
“The net result is that central bank balance sheets have stopped growing and they will start to shrink next year – the Fed’s balance sheet is already down by over $425 billion or 12% from its high.
“It may or may not be a coincidence but since 2009 global stocks have done best when central banks have been adding lots more QE and done worst when they have not.
Source: Bank of England, Bank of Japan, European Central Bank, FRED - St. Louis Federal Reserve database, Refinitiv data, Swiss National Bank, US Federal Reserve
