Equity markets climbed to record highs this week, as investors mostly looked past the Coronavirus and focused on a strong earnings season. Adding to the positive momentum, the Federal Reserve testified to congress that risks appeared balanced at this time and that no additional support was necessary in their view. More than 343 S&P 500 companies have now reported 4th quarter results, with the average earnings beat of 5.2%, and more importantly, guidance looking generally supportive of growth ahead. Also a potential positive, inflation ticked up modestly in January, offsetting the larger fear that economic sluggishness could lead to a disinflationary spiral. Lower rates in fixed income have also bled into the mortgage market, where homebuyers have boosted purchases with increasing affordability, adding to economic activity. The low rates did shift modestly, with the key 3 month and 10 year Treasury yields moving out of inversion territory, a positive for those with fears of recession on their mind.
The Federal Reserve this week provided a glimpse into the mind of policymakers, as they testified to congress on their current outlook as well as how they will face the next crisis head on. They still remain focused on reaching their 2% inflation target on a consistent basis, a goal that has eluded them since the 2008 financial crisis. However, their other objectives of achieving price stability and full employment appear to be on track, and their assessment of the economy was quite upbeat. The bigger issue discussed in their testimony was what policy tools would be available when the next downturn occurs. At this time, Jerome Powell was very frank, noting that with rates as low as they are, limited amounts of rate cuts will be possible to stave off a recession. Further, he added that the Federal Reserve did not support the idea of negative interest rates, as have been used in Europe and Japan, believing the negative side effects are to great on the financial sector and that it leads to a negative feedback loop. Quantitative easing would undoubtedly play a large role again in providing liquidity and boosting risk-taking, but even limits to that tools’ effectiveness is questionable. Once again, Powell and other central bankers are calling for more coordination with and reliance on fiscal policy to take the responsibility for future economic disruptions.
We continue to believe that our current allocations are well positioned for the economic environment we find ourselves in at this time. Our emphasis on a near term cyclical rebound in the economy after last year’s manufacturing recession and trade war disruptions, appears to be pricing into risk assets. Despite fears of the virus outbreak disrupting the turnaround, corporate guidance appears mostly positive, and much needed investment by global companies could boost growth through the rest of the year. Our preference for emerging markets and US equities remains in our equity allocation, as other developed markets in Europe and Japan suffer from low economic activity, poor policy, and weak earnings prospects. That said, we will not be making any major changes to allocations until further opportunities or risks emerge on the horizon. As always, we continue to remain extremely focused on monitoring unfolding market dynamics and reacting only when appropriate. Please feel free to call our office with any questions you may have.