There is the economy and there is the stock market. We have written in the past not to mistake the latter for the former. With the week that just concluded, there is no mistaking that our advice has been heeded.
The stock market might be giddy right now at the thought the economic outlook isn't as dark as it was believed to be at the end of 2018, yet the evidence piled up this week that the global economic growth outlook isn't bright.
That body of economic evidence, and forecasting, was pretty much ignored by the market, which was flat for the week as of this posting but riding high on the faith that the Federal Reserve (and every other major central bank for that matter) will be by its side if it ends up walking through the valley of the shadow of economic death.
Slowdown Lurks in the Shadows
Slowdown shadows were cast this week from multiple angles:
- The IMF cut its 2019 and 2020 global growth forecasts by 0.1 each to 3.5% and 3.6%, respectively, citing among other things the trade tension between the U.S. and China.
- China reported its 2018 GDP growth was 6.6%, which was the slowest pace since 1990.
- U.S. existing home sales decreased 6.4% month-over-month in December to a seasonally adjusted annual rate of 4.99 million, which was 10.3% lower from a year ago and paced by sales declines across all regions.
- The Bank of Japan left its key policy rate unchanged at -0.1% (-0.1%!!), lowered its 2019 inflation outlook, and acknowledged economic risks are skewed to the downside.
- The European Central Bank (ECB) left its key policy rates unchanged at 0.00%, 0.25%, and -0.40 (-0.40%!!), respectively; meanwhile, ECB President Draghi asserted at his press conference that significant stimulus is still needed and hinted that a rate hike may have to wait (as the market thinks it will) until 2020.
- According to a Reuters report, which cited Handelsblatt, Germany cut its 2019 GDP growth forecast to 1.0% (from 1.8% as recently as October).
- CEO after CEO interviewed by CNBC at the World Economic Forum in Davos talked of slower growth, with an underlying theme of a synchronized slowdown standing in contrast to last year when the prevailing theme was a synchronized pickup.
The stock market heard it all, but it wasn't unnerved by any of it. The stock market had some moments of weakness, but that had more to do with some overdue profit taking following many moments of strength since the December 24 low.
A Half Truth
All in all, the stock market held up quite well this week.
Some pundits will suggest the profit-taking interest was relatively limited because the earnings results were better than expected. That's not untrue. It's just a half truth.
The fourth quarter results were better than expected. The blended fourth quarter earnings growth rate increased from 10.6% to 10.9%, according to FactSet, yet it bears pointing out that the projected growth rate was 12.2% on December 31.
Moreover (and most importantly), the projected first quarter earnings growth rate was reduced from 1.3% to 0.7% while the projected calendar 2019 earnings growth rate was reduced from 6.5% to 6.3%.
That's not the direction one wants to see earnings growth estimates going, but it is the prevailing direction now. The prevailing direction of the stock market, however, has been higher, which begs the question, why?
We put forth some answers last week, one of which was Fed Chair Powell's acknowledgment that the Fed will be patient with its monetary policy approach and would alter its balance sheet normalization effort if necessary.
Coincidentally, there was a report in The Wall Street Journal on Friday that suggested the Fed might be getting close to the end of its balance sheet normalization effort. The report added that a decision to end the effort sooner than most expected would be driven more by the debate over a higher level of reserves being needed in the banking system as opposed to a belief the economy needs more or less stimulus.
The report was not confirmed by the Fed, which is no surprise for two reasons: (1) the Fed is in its quiet period ahead of the Jan. 29-30 FOMC meeting and (2) the Fed wouldn't normally comment on such reports anyway.
That FOMC meeting isn't going to produce a rate hike, but it will produce something new. Specifically, it will mark the beginning of a new policy whereby the Fed chair will conduct a press conference following each meeting to discuss the FOMC decision. One can bet that there will be a question or two about the Fed's plans for its balance sheet.
What It All Means
The stock market ran with The Wall Street Journal report, enjoying the thought that the de facto tightening that results from normalizing the balance sheet could soon be over.
The S&P 500 was down 1.0% for the week before that news broke, exposing the main reason why the stock market has been doing as well as it has in the face of disappointing economic news and downward revisions to earnings growth estimates.
The stock market has been born again with the faith that it doesn't need to fear the Fed. The market feared the Fed throughout 2018, which is a major reason why there was multiple compression, and a price decline, at a time when economic growth was accelerating, and earnings growth estimates were being revised higher.
Alas, while economic growth and earnings growth estimates for 2019 are coming down, that reality hasn't seemed to bother the market much yet, because nothing has gone up more than the market's enthusiasm for the idea that it doesn't need to live in fear of the Fed's policy approach.
That could end up being an error in judgment if the economy, and animal spirits, pick up, yet faith is blind, and because the market believes the Fed will stand by its side, it isn't scared of what it sees in the shadows.