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The Fed Has Spoken

Written by Briton Ryle
Posted February 3, 2019 at 7:00PM

Last week, Fed Chief Jerome Powell made it about as clear as it can get: It's time to buy stocks.

Just a month ago, at the December meeting, the Fed statement talked about a strong U.S. economy, with job growth that would inevitably spark inflation beyond the Fed's 2% goal. Powell said the Fed would be hiking rates in 2019 and likely beyond.

That forecast made December a pretty bad month for stocks. The S&P 500 fell 15.7%, from 2,790 on December 3rd to 2,351 on Christmas Eve.

Nearly 16% in less than a month is not good. At all. But then investors were looking at a never-ending trade war with China, weakening home and auto sales in the U.S., a pretty dramatic economic slowdown in both Europe and China, very weak 2019 profit growth for U.S. companies, and a Fed that is raising interest rates.

Now, I am not particularly opposed to Jerome Powell as Fed Chief. But the simple fact is he's never been part of the Federal Reserve system. So I'm not surprised that he had some things to learn as Fed Chief.

The market has clearly been saying that rates were rising too fast. Powell should have backed off before last week. Because it seems the manner with which he capitulated last week — and there are no other words for it: Powell caved to market pressure — means he has certainly lost some credibility with the market.

What's Normal?

Any Fed Chief these days faces some pretty unique challenges. For one, what do you do with that $4 trillion balance sheet that Bernanke left behind? Do you actively sell it off? Or do you simply let it wind down by letting bonds mature? And what is a normal level for interest rates?

Frankly, this question is a really tough one. The Fed has a mandate to maintain price stability and not let inflation get beyond the somewhat arbitrary 2% threshold.

But we're now 10 years from the financial crisis. The U.S. economy has been adding jobs at record pace for years now. The unemployment rate is below 4%, and new jobless claims are likewise historically low. And yet there's been virtually no increase in core inflation.

I believe globalization and technology are deflationary forces that are keeping a lid on prices and salaries. Did you see the Super Bowl last night? Terrible game. But did you notice how many commercials featured a robot? Robots have taken over manufacturing. Next it will be retail. Then, who knows?

Depending on where you live, 20–27% of current jobs will be obsolete by 2030. That's 11 years away...

Globalization works a little differently. The old saying observes that money goes where it's treated best. This means investors put their money to work wherever it can get the best return.

For Walmart, maybe that means getting t-shirts from Asia. For a developer, maybe it means getting financing where interest rates are lowest. In today's connected world, it's easier than ever to get money to the places that will treat it best.

Interestingly, a paper from the New York Fed I perused over the weekend says:

The trend in the world interest rate since the late 1970s essentially coincides with that of the U.S. In other words, the U.S. trend is the global trend over the past four decades. In fact, this has been increasingly the case for almost all other countries in our sample: idiosyncratic trends have been vanishing since the late 1970s. This convergence in cross-country interest rates is arguably the result of growing integration in international asset markets.

It makes sense that the differences would narrow over time as countries become more connected. Anyway. I think the market figured out that Powell was operating on an outdated model of where interest rates should be. 4.5–5% might've been appropriate 15 years ago, but that's clearly not the case now. 3.5% sounds about right to me. Maybe 4%.

In any event, I'm not here to praise or bury Powell. I'm here to tell you that this stock market rally is likely to continue.

Ready... Set...

Yes, stocks have run fast and furious since Christmas Eve. And they've taken back just about all of that brutal December crash. But the S&P 500 remains about 10% below all-time highs, and it's still below its 200-day moving average. 

Now, that moving average is widely considered to be the long-term trend line. So the fact that the S&P 500 is below it will have some people saying that we are still in correction/bear market territory. THIS IS YOUR ADVANTAGE. 

About that recession: Yes, December manufacturing numbers were worrisome. But January's numbers (reported Friday) were solid. The ISM Manufacturing survey made its biggest jump since August to 56.6. And prices paid declined to 49.6.

Even better, the new orders component made its biggest jump in five years! All this suggests that the U.S. economy is cooking, and the trade war isn't hurting as badly as it might. 

So. What stocks should you look at?

Semiconductors are a good place to look. They got creamed during the correction. Pretty much cut in half across the board. But did you see AMD (NASDAQ: AMD) last week? Really solid earnings, and the shares jumped 20%. AMD is not really a leader. But that solid earnings report could still help turn sentiment. 

Next up, weed stocks. They were smoking hot last week. And legalization is very likely to become a front-page item soon. My favorite weed stock ran an amazing 38% in January, and there's more to come...

Gotta say, I'm not wild about the mega tech companies right now. Apple's issues run kind of deep, regarding a lengthening replacement cycle for phones. And Amazon may be boosting spending, which will hurt its numbers (but likely help some of the companies that support Amazon's growth).

There ya go... I'll talk to you again on Wednesday.

Until next time,

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Briton Ryle

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A 21-year veteran of the newsletter business, Briton Ryle is the editor of The Wealth Advisory income stock newsletter, with a focus on top-quality dividend growth stocks and REITs. Briton also manages the Real Income Trader advisory service, where his readers take regular cash payouts using a low-risk covered call option strategy. He also contributes a weekly column to the Wealth Daily e-letter. To learn more about Briton, click here.

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