On Wednesday the Federal Reserve signaled that rate hikes are on hold, and also indicated it might adjust the rate of balance sheet shrinkage. Currently, the Fed is reducing its balance sheet by $50 billion monthly, or $600 billion annually. A shrinking balance sheet has been estimated to equal at least two additional rate hikes already. The impact on the cost of money might be even greater. According to Benn Steil and Benjamin Della Rocca of the Council On Foreign Relations, one analysis has the Federal Reserve’s balance sheet runoff equaling 2.2% in additional rate hikes by year-end 2019 at the current pace.

If correct, the cost of money has risen substantially more already than indicated by the Federal Funds rate hikes, and the impact on the economy will likely be greater than many are anticipating.

Nevertheless, investors reacted to the dovish talk by pushing the S&P 500 decisively through 2670, where the index had stalled twice a week prior. The S&P 500 finished Friday at 2706.56, up 1.6% on the week. The relief rally (still most likely) is now 26 trading days old. The Fed has given it new life with its apparent monetary policy change; however, the expected economic slowdown might be more severe than many believe. A heavily indebted economy is less able to deal with the tightening that’s already occurred, both directly with rate hikes and indirectly with balance sheet shrinkage.

Earnings estimates are falling. Analysts forecasted a 10% rise in 2019 earnings last fall, but are now looking for less than 6% earnings growth. A growing number of analysts are expecting negative corporate earnings growth in the first quarter of 2019. Pricing power in the U.S. in the fourth quarter of 2018 was weakening. “Based on such diverse items as transportation, apparel, and commodities, price weakness was widespread in the fourth quarter, suggesting final demand is weak relative to productive capacity,” writes Dr. Lacy Hunt of Hoisington Investment Management. He goes on to write: “Exports, vehicle sales, and home sales exhibited characteristics of sectors in recession.”

Stock investors may be right in bidding up the S&P 500, but we think it increasingly likely that the U.S. economy is in for a pronounced slowdown. We are in line with Mike Wilson, Chief Equity Strategist for Morgan Stanley, who is currently recommending that investors wait to buy until the relief rally ends and stocks, once again, move lower. Of course, that also applies to individual stocks, which means we buy when we find a good company on sale, regardless of what the overall market is doing. 

INVESTING