Ever Changing ... Never Changing

We titled our third-quarter 2018 market commentary “Goldilocks and the Three Fears” because our thesis was that the U.S. economy was in a well-balanced environment marked by low inflation and relatively strong economic growth. Still, investors were worried about three things: the Federal Reserve tightening the U.S. economy into submission; ill effects from the U.S.-China trade war; and fears of being the last person in before a big market plunge. We felt that all three of these fears would dissipate and the economy and markets would continue hitting new highs. The trio of fears caused an ugly fourth-quarter 2018 market plunge that drove U.S. large cap stocks down by nearly 20 percent, but throughout 2019 these fears all faded — as expected — and stocks posted a banner year as a result.

In January 2019, the Federal Reserve reversed course and broadcast to investors that the central bank was prepared to bolster markets through economic troubles. This promise kept markets afloat while the trade war twisted and turned and fueled uncertainty throughout the first three quarters of 2019. Trade uncertainty peaked in the third quarter as political tensions reached unprecedented heights and threatened to topple both the economy and markets. However, we held fast in our belief that some sort of a trade deal would be reached in the fourth quarter. As 2019 ended, the U.S. and China finally agreed to a phase-one trade deal that has cooled the political temperature.

Although investors are now less fearful, sentiment remains relatively subdued and far short of euphoric levels that typically precede market contractions. We note that investors continue to park elevated levels of investible dollars in money market funds, which we view as a positive because we believe these “dry powder” reserves could provide fuel for continued equity market gains in 2020, given our forecast for a U.S. and global economy that continues pushing higher.

Despite our relatively positive outlook, geopolitical and recessionary fears are still noisy. However, if you filter out the chatter, you’ll hear a normal, healthy business cycle ticking in the background. We think 2020 will be much quieter than 2019, and that should allow economic fundamentals to steal the show. And if the market party gets too rowdy, no worries, the Federal Reserve will not follow its historical script of removing the punch bowl by raising interest rates to moderate growth. As the 2010s close and the 2020s are ushered in, investors need to understand the secular shift in the Federal Reserve’s playbook. Let us explain.