World Economy

A ‘baby bear’ market scared the Fed into pausing

The financial markets were convulsing with worry about a slowing economy, and the Federal Reserve chairman sought to reassure investors the central bank got the message.

“A complex business cycle process is underway, whose outcome is yet to be determined. For the Federal Reserve it is a time… to gauge whether policy is still appropriately positioned to foster sustained economic expansion…It is clear, especially in the last month or two, that inflationary pressures are easing.”

The chairman was Alan Greenspan and the year was 1995, shortly after the Fed had halted a year-long tightening campaign that investors feared might have gone too far.

But it could also have been Janet Yellen, who as chair said this in early 2016 not long after a controversial December 2015 rate hike left markets unsettled: “I consider it appropriate for the committee to proceed cautiously in adjusting policy…The decline in some indicators has heightened the risk that” growth could falter. “If so, the return to 2 percent inflation could take longer than expected and might require a more accommodative stance of monetary policy.”

Not so different from Chairman Jerome Powell last week, using a form of the word “patient” eight times in conveying policy flexibility after a December rate hike – and signals of more to come – unnerved markets.

You get the idea. Over more than three decades and four Fed chiefs, there have been a half-dozen sharp market downturns driven by a growth scare, outside of a U.S. recession. In each case, the market retrenchments relieved valuation pressures, punctured investor confidence, led to moderate growth and tame bond yields — and forced central bankers to pause tightening programs or even to ease policy.

The bullish case for stocks today rests on the expectation that the 20-percent bungee-jump late last year will prove another one of these “baby bear” markets that was a false recession alarm and will give way to a “just-right” Goldilocks growth phase and release stock prices toward new highs. A probable script, or a hackneyed tale too good to be true?

Tony Dwyer, strategist at Canaccord Genuity, has been characterizing the late-2018 collapse as the fourth “non-recession market crash” of the past four decades, using 1987, 1998 and 2011 as the relevant precedents — with bullish implications longer term but a hint that another short-term retreat might be needed.

The 20-percent break in the S&P 500 into late December, Dwyer argues, “more than discounts the slowing domestic and global economy, as long as the Fed stops making policy and communication mistakes, the Trump administration resolves the trade conflict with China, and the yield curve remains positive.”

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