Corporate earnings are expected to contract in the first quarter and fears of an economic slowdown abound. Yet the U.S. stock market is still up more than 13 percent this year. There is one reason why these opposing scenarios are developing simultaneously: an accommodative Federal Reserve.
The Fed said Wednesday it does not expect to raise rates once in 2019, three months after forecasting at least two rate hikes. The central bank also said it expects to end its balance-sheet reduction process by the end of September. Wednesday's news came after the Fed said in January it would be "patient" in raising rates moving forward.
For now, investors are betting the central bank can keep the equity market afloat even as corporate profits decline and the economy slows down. They believe earnings don't have to grow all that much this year to justify higher share prices as long as interest rates head back lower.
"After this week's Fed meeting, it is clear that the dovish turn is here to stay, and this should be a sustained tailwind for risky assets," Marko Kolanovic, global head of quantitative and derivatives strategy at J.P. Morgan, wrote in a note on Thursday. "This is an enormous shift in monetary policy, which we believe is not fully priced into various assets such as risk-on currencies, and Equities, Commodities, and other Value assets."
The Fed's dovish stance is the opposite image of last year. In 2018, the Fed raised rates four times and appeared determined to continue normalizing monetary policy. This brought fear of a potential policy mistake into the market, as the S&P 500 posted its worst annual performance since 2008.
This year, investors are cheering the Fed's sharp pivot. The S&P 500 is about 3 percent below an all-time high set in September after dipping into bear-market territory on an intraday basis back in December.
"For now, we think the easing in financial conditions is supporting the US equity market, a prevailing theme for much of the post-[Great Financial Crisis] period," Alex Timcenko, an analyst at Bernstein, wrote in a note Thursday. "Seen in this context, the Q4 equity market decline is not hard to explain; it coincided with a sharp tightening in financial conditions. The subsequent YTD rebound has coincided with an easing in conditions and is also justifiable on these grounds."