In April we sent out a blog with a few charts indicating how we perceived the market to be in a short-term perilous position. We also indicated that based on other historical data, the possible upcoming correction should have resolved in a positive longer-term reaction.
Two months since our call, the market has indeed corrected and retraced most of its down move. It is difficult to think that we may be completely out of the wood so quickly in the face of continued geopolitical friction and deteriorating consumer sentiment. However, the market is underpinning its hopes on a radical u-turn from the Federal Reserve.
The Fed has quite clearly indicated an intention to be very patient in light of the recent deterioration of economic data. Such dovish messages have been interpreted as pre-announcement of imminent rate cuts. Bloomberg indicates that market expectations for three rate cuts before the end of the year (yes… that is three….) are now at a whopping 60%. In the last 40 years, we had three instances in which the Fed cut three times and then stopped. In 1987 to respond to the market crash, in 1995 to recalibrate monetary policy after aggressive rate increases and then again in 1998 to offset the LTCM blow-up.
Given that two out three precedents were induced by financial crises and that would not seem to be the case currently, the 1995 situation is the only one sharing some similarities. The rate cuts the Fed delivered then helped the economy produce a soft landing and that led to the massive rally into March 2000 (along with more liquidity injections at the end of 1999 to counterbalance the possible crunch from the Y2K issue). It must be said that this time around we are much deeper into our economic cycle and therefore restarting the economy might be more difficult. In 1995, the world also was on the verge of a productivity increase due to new technologies (i.e.internet) . While we are presently working on interesting new developments such as AI or biotech solutions, it is still unclear if they could be as sweeping changes as it happened 25 years ago.
Ultimately, everything hinges on avoiding major political mistakes, but a dovish Fed is every investor’s best friend.