Stockmarket Should Remain Strong as Long as Fed Avoids Misstep

The major U.S. stock indexes finished mixed last week with gains being posted in the S&P 500 Index and NASDAQ Composite, while the Dow Jones Industrial Average lagged behind. It was a busy week in regards to corporate earnings, Fed activity and economic data with all factoring into the price action at some time or another, however, all these news events generated very little change in prices.

While all eyes were on the large-cap U.S. stock indexes, small-cap and international stocks outperformed the bunch. This suggests U.S. markets may be overcooked to the upside since the economy hasn’t really missed a beat, while beat-up international stocks may have more appeal because the global economy may be in a position to turnaround. In other words, we could be looking at an allocation play whereby asset managers sell-off some of the good stuff and move money into the cheaper stocks with more upside potential.

There really wasn’t much to rattle stock traders last week except for potential valuation issues. This raises the question, will U.S. investors still be willing to chase the market higher at current price levels, or will they be more willing to book some profits and wait for a pullback into a value area.

Last week’s domestic economic reports were mixed, but for the most part were still positive. We saw a rise in consumer confidence and productivity. Additionally, the U.S. economy added 263,000 jobs in April and the unemployment rate hit a nearly 50 year low. Wage growth was steady, but still disappointing to some. From a positive perspective, this indicates that the labor market can continue to support economic growth without spiking inflation higher.

The U.S. Federal Reserve actually came in a bit less-dovish than expected. The big surprise to some market participants is that the central bank reduced the chances of a rate hike last year with their commentary. Central bank policymakers reiterated their patient approach to setting rates, but also signaled that due to strong labor growth, it wasn’t preparing to cut interest rates. This triggered a light sell-off toward the end of week by investors who had priced in a more-dovish Fed.

Nonetheless, stock market investors seem to like Fed policy at this time because it doesn’t suggest a rate hike is on the horizon. Traders would rather have the central bank hold rates steady then raise them. A rate cut would’ve been the cherry on top, however.

Moving forward, the stock market should remain healthy since Fed policy is accommodating. The economy is also healthy although slow-moving. As long as inflation remains slightly under the Fed’s 2 percent target, the policymakers really have no choice but to watch how conditions unfold.

While Fed stimulus has helped generate solid returns in the stock market, there is evidence that this bull market is now being supported by improving fundamentals. Recent data shows steady consistent growth in the economy and corporate profits. And over the last six-months we’ve seen what raising rates too fast can do to the stock market.

Furthermore, April’s jobs report highlighted the strength in the labor force. Unemployment is low, wages are rising steadily and this is helping to boost household spending, which essentially holds together the economy.

As earnings season comes to a close, investors will look back and see that corporate earnings results have come in ahead of expectations when less than a month ago experts were calling for the worst season in three years. This is important because even with the relatively low interest rate environment, earnings growth will continue to remain a key driver of market performance the rest of the year.

While we remain optimistic about future growth in the stock market, we are being realistic when we say that there are potential pitfalls out there including the possibility of a Fed misstep, a collapse of US-China trade talks, political uncertainty regarding the White House and fallout from Brexit.