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U.S Federal Reserve Juiced Stock Market Could Drop 20%

Both Canadian and U.S. equities are trading near, or at, record highs. The S&P 500 is up 21% year-to-date and the TSX had advanced 19.25%. These strong gains come amidst a time when the global economy is showing serious signs of weakness, thanks in large part to the U.S/China trade war. Why the strong double digit gains then? It has nothing to do with underlying fundamentals. Stocks are rising because the Federal Reserve, and central banks around the world, are lowering interest rates. A lack of any meaningful growth from stocks could result in a 20% sell-off, just like we experienced in the fourth quarter of 2018.

On September 18, the U.S. Federal Reserve cut its key overnight lending rate by 25 basis points to between 1.75% and 2%. This is the second time in as many months that the Federal Reserve has opted to cut its rates. Something it has been forced to do because of the global slowdown that has come as a result of the U.S./China trade war.1

This may not be the last rate cut of the year either. Federal Reserve Chairman Jerome Powell has said that because of the trade war, additional cuts could be coming. Powell didn’t say for certain he would be making any more cuts this year, but it’s looking increasingly likely.

Trade War Forces OECD to Cut Its Global Growth Projections

Because of the U.S./China trade war, the global economy is expected to grow at its weakest pace since the 2008-2009 financial crisis. This prompted the Organisation for Economic Co-operation and Development (OECD) to slash its global growth forecast. The global economy is projected to slow to just 2.9% in 2019 and 3.0% in 2020. Back in May, the Paris-based forum predicted the global economy would advance 3.2% in 2019 and 3.4% in 2020.2

It also cut its gross domestic product (GDP) growth forecast for the world’s two biggest economies. The U.S., which is home to the largest economy, will see its GDP slip to 2.4% in 2019 and 2.0% in 2020; this is down from 2.8% and 2.3% respectively from its May forecast.

China, the second biggest economy will see its GDP grow 6.1% in 2019 and slow to 5.7% in 2020. It had previously forecasted Chinese GDP to grow 6.2% in 2019 and 6.0% in 2020.

As for Canada, the results are mixed, the OECD expects Canadian GDP to grow 1.5% in 2019, up from its May forecast of 1.3%. In 2020, Canadian GDP will slow to 1.6% from its May projection of 2.0%.

The U.S. Federal Reserve is not the only central bank lowering its rates to help juice the economy. Since the start of 2019, central banks in Australia, Brazil, Chile, Hong Kong, Iceland, India, Mexico, Philippines, Russia, Serbia, South Korea, South Africa, and Thailand have cut their rates.

There is only so much economic stimulus that central banks can do. They will eventually run out of tricks to support the economy. Even with lower interest rates, a slowing economy is expected to hurt equities in the back half of 2019 and early 2020. Optimistic investors, caught off guard, could result in a fourth quarter sell-off.

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Central banks around the world are lowering their interest rates in an effort to energize their slowing economies. This in turn forces income starved investors to make risky trades on stocks, which sends equities higher. Remove the fuel, and stocks will have to stand on their own merit. And right now, fundamentals do not support nosebleed valuations. The trading experts at Learn-To-Trade.com can show you proven trading strategies that can help you profit no matter what the markets are doing.

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Sources:

  1. Timiraos, N. “Fed Cuts Rates by Quarter Point but Faces Growing Split,” Wall Street Journal, September 18, 2019; https://www.wsj.com/articles/fed-cuts-rates-by-quarter-point-but-faces-growing-split-11568830081?tesla=y&mod=article_inline&mod=hp_lead_pos1.
  2. “OECD sees rising trade tensions and policy uncertainty further weakening global growth,” OECD web site, September 19, 2019; http://www.oecd.org/economy/oecd-sees-rising-trade-tensions-and-policy-uncertainty-further-weakening-global-growth.htm.

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