There has always been some disconnect between stocks, bonds, and the economy. Stocks and the people who own are often the optimists of the group. They look forward and try to extrapolate the future winners and losers, willing to pay multiples of earnings or revenue in order to own a part of a company’s or industry’s future. Bonds and the people who own and trade them are often market realists. In an industry where every 1/100 of a percent matters, bonds try to reflect the future direction of the economy given what is going on in the world today.
Today, stocks as measured by the S&P 500 and the NASDAQ are hitting new highs despite bonds signaling a slowing economy ahead. How that happens goes back to Fall 2018 when the Federal Reserve steadfastly rose rates in December as part of their plan to “normalize” or raise them throughout 2019. In a little over six months we have gone from the belief that the Fed could serially raise rates throughout 2019 to the thought that the Federal Reserve could lower rates by as much as 50 basis points as soon as July.
This pivot by the Federal Reserve was grounded in the escalating fears of recession brought on by the uncertainty in trade negotiations with China and others as well as signs of slowing corporate profits. These fears of recession have arisen despite record low unemployment and a strong consumer. It seems clear that ultimately the Federal Reserve did not have the fortitude nor the need to raise rates in this economy once challenged by Wall Street to stop or face the consequences of a bear market in a slowing earnings environment. Ultimately, neither Federal Reserve Chairman Powell nor his colleagues wanted to kill what is left of the expansion, so the Fed is back in the stock market’s corner for now.
While there could be pressure on corporate earnings in the middle part of the year due to trade tensions, I suspect, barring more tariffs, this will be a steady as she goes market. The stock market successfully scared the Federal Reserve back on their side and stocks for now feel pretty good about that. After all, they tend to be optimists.