Stocks rallied on Wednesday with the S&P 500 surging 2.3% following comments by the Federal Reserve Chairman Jerome Powell that interest rates “remain just below” the neutral level for the economy, suggesting rate hikes may slow down.
The market reaction is unsurprising since investors have been concerned about the Fed raising rates too quickly and cooling the economy. The recent market slide that began in October was accompanied by Chairman Powell’s comments that rates were “a long way” from neutral, suggesting more rate hikes were coming.
I can’t explain the Fed’s apparent switch in under two months. Perhaps the market is reading too much into one comment or the other, or perhaps the Fed is concerned about recent slowing in economic data. Regardless, jittery investors are reacting (perhaps over-reacting) to any signal about near-term direction.
We are in a headline-driven market. Rising rates a concern? Suggesting rate hikes will slow sends stocks soaring. Worried about a trade war? Belligerent comments on tariffs spark a sell-off. Near term uncertainty means the latest news drives markets.
What risks do investors see?
- Interest rates: Rising rates are cooling the housing market, a leading indicator for the economy, and are raising costs of investment for companies.
- Trade war: Tariffs will slow exports and raise costs, causing inflation and squeezing profit margins.
- Inflation: Rising wages and input costs will hurt corporate profit margins and slow investment.
- Global growth slowing: In part due to the trade war, many countries are seeing growth slowing, particularly China and Europe.
The market will remain headline-driven and volatile until these risks are resolved or a new story grabs investor attention.
While the market rallied on the possibility of fewer rate increases, if new data shows inflation picking up, more rate hikes will be back on the table and stocks will react accordingly.
This weekend’s G20 meeting may bring news of a trade deal with China, or not, and next week could see the market move sharply higher or lower. With the threat of increased tariffs in January, the market will want to see progress sooner rather than later.
It’s nearly impossible to predict the headlines. Some investors predicting a trade deal (or no deal) this weekend will inevitably be proven right, but that doesn’t make them smart. Anyone being honest will admit they have no idea what will happen. I don’t.
What should investors do in a headline-driven market? The only defense is to have conviction in your investments and a long-term focus. This period will pass – eventually. The key is to understand what you are invested in, make sure your risk is appropriate, and stick to your time horizon. While current volatility is higher than recent years, it is not abnormal, and should be viewed as the cost of investing in the market.