The Fed chose not to begin its rate-tightening cycle this month, citing concerns over a slower-than-desired inflation trend, weak global economic growth projections and heightened financial market volatility. In a replay of reaction to last month’s July FOMC minutes, investors again can’t help but wonder if the Fed’s reluctance to recalibrate is cloaking a much more serious concern.
Yes, we believe the Fed’s inaction does remind investors of the global economic fragility and the vulnerability of financial markets. A worldwide economic slowdown, or even recession, continues to be of concern, but is not the likeliest outcome, in our view. Indeed, Standard & Poor’s Economist recently stated that, “As the U.S. economy edges back toward full employment, the Fed's cautious and well-telegraphed monetary policy normalization is unlikely to upset the global growth apple cart.”
What’s more, the concern surrounding a profit recession – normally a reliable predictor of general economic contraction – is tempered by the prospects for a “V-shaped” EPS recovery, as a result of the passing of the one year anniversary of the steep decline in energy sector earnings. Yet market pressures remain, and will likely cause the August 25 correction low to be retested, if not surpassed.
In the meantime, U.S. dollar-denominated assets have been given at least a temporary stay of execution. Finally, directional clarity for S&P 500 sector remains cloudy at best, causing us to resist the temptation to tinker with weightings until we feel more confident of a recovery.