The Fed: More Goldilocks
While it may seem boring, this is important from the standpoint of your investment portfolio: yesterday, as expected, the Federal Reserve raised its Federal funds (overnight interbank lending) target rate range by 25 basis points to 1.75-2.00%. The importance is not so much the rate itself (still highly accommodative) but rather the outlook commentary and posture of the Fed’s economic viewpoint. The viewpoint appears to continue to support a “goldilocks” environment for stocks.
The Fed’s commentary following its FOMC meetings is sliced and diced six ways to Sunday by the media and investment industry pundits. Our take on the Fed’s commentary is pretty straightforward: 1) the Fed is essentially saying that the economy is looking very good; 2) inflation and inflation expectations remain stable and moderate, around 2%; 3) there is no change in the Fed’s interest rate policy, which is continued steady quarterly increases in the Fed funds rate: two more this year and probably three more next year. We believe this outlook is actually quite positive (almost “goldilocks”-ish) for stocks because it indicates the Fed, in both its actions and outlook, remains committed to providing a monetary backdrop that is conducive to economic growth which, in turn, is supportive of corporate profit growth, the single most important driver of stock prices.
Some pundits have raised alarm bells that the Fed rate policy ultimately sets the stage for inverting the yield curve and tipping the economy into a recession. These same pundits take a guess at when the next recession starts, and some of them are now saying 2020. While pundits are paid to write and stay stuff that sounds smart (and granted many of them are smart), we respectfully submit that not only is it difficult to forecast a recession, but also we believe the current expansion could be surprisingly durable and last longer than many now expect. Our reasoning? Currently there do not appear to be major economic or financial imbalances that usually precede an economic downturn. Inflation continues to remain moderate. Fed policy remains accommodative. The corporate profit outlook remains healthy. Valuations based on forward P/E are not exceedingly high at 17x.
So what does this have to do with financial planning? We, as a fiduciary to our clients, need to have a framework for setting investment policy. Along with factors such as the economy, inflation, corporate profits, valuation, and geopolitical risks, Fed policy is a critical element in assessing the investment environment. Based on these factors, we still believe the outlook for stocks remains quite positive and this gets reflected in our allocation to equities, which we are currently overweighting in our strategies . While the risks of a trade war have been prominent in the news of late, at this point, we still believe the risk of an all-out damaging trade war remains low. We will be holding our Q3 investment strategy meeting on June 27 and will have a further update on our investment strategy at that time.
Robert Toomey, CFA/CFPVice President, Research