As we approach our national day of Thanksgiving in the US, individuals are naturally thankful for family, friends and, hopefully, good health. Cheers to that! This year, particularly after last year’s tough fourth quarter, investors are also very grateful for the bountiful harvest of capital market returns. In many ways, investors can’t believe their good fortune. Despite slowing global economic growth, stagnant corporate profits, volatile trade tensions and rising geopolitical risks, US stocks continue to reach all-time highs. In addition, spreads between US Treasury and corporate bond yields remain historically tight, suggesting a sanguine environment for credit markets. Not to mention that most measures of market volatility are signaling the all-clear ahead. Sometimes it is better to be lucky than good.
Legendary investor Sir John Templeton famously said, “Bull markets are born on pessimism, grown on skepticism, mature on optimism and die on euphoria.” This unusually unloved bull market doesn’t exhibit any of the classic signs of euphoria, perhaps further rewarding investors with guts and staying power. However, when investing conditions seem foolproof, shrewd investors continually ask, What am I missing? They proactively seek out opposing viewpoints. Conversely, when the investing landscape is crashing, prudent investors remind themselves of the benefits of a long-term horizon, the power of diversification, the discipline of a proven process and the opportunity to put capital to work at much lower prices.
So although today’s investing environment is hardly euphoric, returns have been outstanding this year and throughout this decade. As a result, many of my recent Uncommon Sense warnings may seem overly cautious at a time when many benchmarks are reaching new heights. I feel a strong obligation to use this platform to push our collective thinking in potentially uncomfortable ways that enable us to ask ourselves, What could go wrong? However unpleasant, there will come a time when markets collapse and together, we will have to find the courage to stay disciplined and, if appropriate, gobble up bargains with abandon.
In the meantime, while we anxiously await what’s next in today’s markets, I’ll enjoy two of my favorite holidays in November — Veterans Day and Thanksgiving. Three if you count my birthday as a holiday. Who doesn’t count their birthday as a national day of celebration? But I digress. Anyway, in a year when seemingly lots could have gone wrong, I thought it would be refreshing to take a much-needed break from my Chicken Little Syndrome and reflect on what investors are truly thankful for this Thanksgiving.
Let’s Talk Turkey
At the top of the list of things that investors should be thankful for this year is the US Federal Reserve (Fed). Despite President Trump’s constant whining and calls for much lower interest rates, the Fed has delivered in spades. The Fed has slashed interest rates by 75 basis points over the past few months to a target range of 1½ to 1¾ percent, all but eliminating last year’s rate increases.
In early October, at a rare unscheduled meeting, the Fed committed to purchasing Treasury bills into at least the second quarter of next year in order to maintain reserve balances at or above the level that prevailed in early September. At that same October meeting, the Fed pledged to conduct term and overnight repurchase agreement operations through at least January 2020 to “ensure that the supply of reserves remains ample even during periods of sharp increases in non-reserve liabilities, and to mitigate the risk of money market pressures that could adversely affect policy implementation.”1 This latter action was the stunning extension of the Fed’s response to unexpected pressures in the repurchase (repo) market that began in mid-September. Still, many market observers and central bankers dismiss this extraordinary policy response as nothing more than addressing a repo market structure issue, a so-called plumbing problem. The Fed refuses to label either of these two actions as quantitative easing, but we know better, don’t we?
The three Fed rate cuts, the commitment to purchase Treasury bills and the promise to conduct repurchase agreement operations have pushed short-term interest rates lower. At the same time, long-term rates have modestly increased as fears of recession have receded and optimism regarding a potential phase one US-China trade deal has grown. As a result, the yield curve has steepened over the past several weeks. The Fed has successfully and purposefully un-inverted the yield curve through their powerful policy responses. This has further flattered stock prices to new all-time highs, particularly for portions of the market that were previously out of favor, such as cyclicals, value stocks and financials.
Sorry, Mr. President, but the Fed has helped you out, bigly. And investors everywhere are grateful to the Fed this Thanksgiving.