There is rising apprehension that Federal Reserve policy could ignite a bear market.
The markets have reached historically high levels. There is some concern that lofty market valuations combined with a contraction in Federal Reserve monetary policy might ignite a bear market.
Already the markets are showing weakness. The first quarter may end in negative territory. If so, this would be the first quarterly loss in global equities in two years.
Uncertainty over trade policy may be the primary driver of the U.S. stock market at the moment. However, the real policy risk facing equities could be coming from the Federal Reserve. The potential consequences from a misstep by the Federal Reserve would be more severe than investors are currently anticipating.
Last week, Fed Chairman Jerome Powell said the economic outlook had strengthened. Nevertheless, he painted a mixed picture about what policy might look like going forward. The U.S. central bank raised interest rates but indicated it would only do a total of three rate hikes in 2018. Some saw this as a dovish signal. Many investors had expected four this year. Instead, the Fed pushed up its expected rate path in 2019 and 2020.
Barry Bannister is head of institutional equity strategy at Stifel. He said that it was a concern that the Fed’s view for 2019 and 2020 had grown more hawkish. This raised the risk of the central bank making a policy mistake.
“What matters for investors is that any decline is likely to be unusually rapid and occur as a result of P/E compression, resulting from policy risks not weak GDP.” “Investors need a bit more acrophobia. Our best model points to a bear market and a lost decade for stocks.”
