The New Normal

                Talk of the “new normal” developed several years back, in the wake of the financial crisis. Mohamed A. El-Erain, a widely regarded voice in the world of finance and investments, is often given credit for originating the idea.  He began using the term to describe the then struggling low growth economy, the resultant quantitative easing (monetary policy enacted by the Federal Reserve), and the persistent low interest rate environment. 

Today, we are thankfully well beyond the financial crisis.  One important point El-Erain made was there were limitations, and notable downside risk, to perpetual reliance on central bank intervention.  Traditionally, monetary policy was intended to either stimulate economic growth or tamp down inflation.  My concern is that the new “new normal” is the politicization of the Federal Reserve.  What we are seeing is Washington commanding monetary policy intending to influence stock prices.  The downside of this new normal is the risk that stimulus stops working to spur economic growth.  Higher stock prices allow politicians to lay claim, but they do not correlate with the general economic well-being.

The question on my mind is how long can the party last?  We are in the late stages of an economic upcycle and Wall Street seems to be on a liquidity driven sugar high.  There are many investors who hope an extension of the current demagogic regime in Washington will perpetuate the good times.  And, the flip side of that coin is that if reasonable adults are brought into the nation’s capital once again, there will be a huge let down as all the excess will have to be accounted for.  In my opinion, either scenario ultimately gets us to the same place, just passing across vastly different landscapes.

At the moment, a wave of complacency is dominating investor behavior.  After a robust 2019, stocks have taken a breather in the first month of the new year – prices ended down 0.2% to start the year.  Stocks had been over-bought, so this down blip is not overly important.  For some context, this was only the third down month in the last 12 (fourth in the last 14).  At one point in January, stocks were up over 3%.  The long-term uptrend remains in place, and most investors are uncritically deflecting any bad news that comes along. 

The coronavirus is the most recent speed-bump for the stock market.  Uncertainty over the virus and its potential negative impact on travel, tourism, trade, supply-chains and retail sales (Apple stores, for example) is causing investors to take pause.  The worry is that economic growth will suffer, and thus earnings will come down.   If the SAARs outbreak in 2002 is any indicator, the impact of the coronavirus will hopefully be only temporary.

One of the byproducts of episodes such as the coronavirus is that it led investors to take safe haven in US Treasury bonds.  This buying has pushed the yield on the benchmark 10-Year US Treasury bond down near its lows, in the 1.5% range.  A temporary move like this will only invite political pressure on the Federal Reserve to lower the Federal Funds rate.  This in turn will likely perpetuate the liquidity driven stock market rally.

We are roughly half way through 4Q 2019 earnings -the reports and outlooks for the coming year are pivotal.   Thus far, the spectrum of results has been dramatic, with some clear disappointments (Caterpillar) and some surpassing already high expectations (Amazon).  The potential for a true inflection in earnings this year remains firmly in place.  From the beginning of each year, analysts typically lower their earnings forecast as we move deeper into the year.  For now, the call is for a nearly 10% jump in earnings in 2020.

Looking ahead, we need to see some robust earnings.  The market’s multiple is in the high end of a range.  Strong earnings will allow stock prices to move higher for more fundamental reasons, those which provide greater staying power and are more reliable than external factors.  There are other cautionary signs which may cause trouble but nothing clearly imminent.  My expectation is that improved earnings reconnect stock prices to their fundamentals.  This will enable our growth oriented domestic stocks to continue to generate returns.  Please look for a call from us to schedule a review if we have not been in touch recently.

Bruce Hotaling, CFA

Managing Partner