Stocks rallied once again on Friday as President Trump prepared to take off for talks with Kim Jong-Un over nuclear disarmament.
The driver of Friday’s rally was comments last week from Fed officials suggesting that the Fed was now focused more on seeing inflation rise to or above its 2% target than taking rate action to affect the rate of growth. It suggests comfort that while growth may be slowing for now, the risk of recession remains low. The Fed has dual mandates of maintaining price stability (which, in Fed terms, means keeping inflation as close to 2% as possible) and promoting growth. Both cannot have equal weight at any moment in time. For instance, post the Great Recession, there were times when promoting and accelerating growth was paramount. There were times when boosting inflation was the primary target. There were even times when unemployment was falling that the Fed was concerned about rising inflation pressures.
But now it appears that employment growth may have peaked. We have just witnessed two months of 300,000+ job gains, but that streak is likely to end with the February report. Unemployment claims are rising and overall growth is falling. While we still expect solid employment growth, if job creation is about to slow, the inflationary pressure associated with possible full employment might soon dissipate.
Wall Street likes the idea that the Fed is not going to raise rates. The fact that it might wait for inflation to rise to a sustained rate above 2% means the threat of any further rate increase is suspended for even more months. Investors celebrated on Friday. Indeed, it is possible that inflation won’t reach 2% without further stimulus from the Fed (i.e. a rate cut). In theory, lower rates are favorable to stocks. But should lower rates signal a weakening economy, and thus precipitate a rate cut, the threat of a weakened economy and lower earnings would likely offset the beneficial impact of lower rates.
The other big news item this week – the meeting between President Trump and Kim Jong-Un is unlikely to have any noticeable economic impact. I’ll leave the politics of any outcome to others. But North Korea is barely a blip on the economic map and the other associated risks from North Korea are too low to matter economically, at least at the moment.
Which brings us back to earnings and valuation. Earnings momentum is definitely slowing. The sustained dollar strength won’t help. In addition, as we noted on Friday, should tax refunds lag as early signs indicate, second quarter momentum may slow further, endangering profit growth for the first half of the year. With that said, dollar pressure should weaken in the second half, lower interest rates will boost rate sensitive industries, like housing, and the impact of lower tax refunds will be a one-time event. Thus, while full valuation may merit some short term correction after a sharp recovery in 2019 to date, we see no basic change in the long term upward trend. No recession, no surge in inflation, and a reasonably stable political environment with less trade related risk probably means the long term path for stock prices is higher.
Today, actress Téa Leoni is 53.
James M. Meyer, CFA 610-260-2220