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January Economic Update

Market Summary

In spite of continued positive economic news, last month will be remembered for the uncharacteristic drop in the equities market. The month of December, and the fourth quarter in general, has historically yielded strong returns. In contrast to history, the S&P 500 dropped a sharp 10.16% for the month. The causes for the decline are the same triggers which have concerned investors for months now: the Federal Reserve raising interest rates too quickly and concerns about tariffs abroad.

There were additional worries which compounded the sentiment, including a government shutdown, questions about the Brexit, and potential slowing growth globally. In steep contrast, our economy seemingly remains fundamentally strong with low unemployment, high consumer confidence, and strong consumer spending. (1)

The Federal Reserve & Interest Rates

Arguably, the greatest cause for the selloff was the continued rise in interest rates by the Federal Reserve. First, let’s take a look at the Federal Reserve, their role in controlling economic growth, and the impact of rising and falling interest rates. The Federal Reserve sets interest rates which impact the cost of borrowing for banks and consumers alike. When interest rates are low, the cost of borrowing money is low and economic growth usually follows (such was the case after the Financial Crisis in 2008/2009). The inverse is also true; when the Fed raises interest rates the economy will “pump the brakes.” When the economy is firing on all cylinders, the Federal Reserve will step in and raise interest rates to slow the growth.

It seems counter-intuitive to want to slow an economy down, but it is fundamentally necessary to prevent large “boom and bust” cycles from occurring due to speculative bubbles forming during strong rises in asset prices. Before the Great Depression, the roaring economic conditions of the 1920s led to speculative bubbles followed by the inevitable, unprecedented drop which led to economic turmoil for over a decade.

Last year, the Fed raised interest rates steadily in light of the strong economic conditions. The rise in interest rates has seemingly done little to slow economic growth so far, but it did put fear into the broader stock market. Few economists, fund managers, and investors expected such a sudden fall in stock prices and market sentiment considering the fundamental economy remains strong. Recently, the Federal Reserve has responded to this overreaction and stated that they would “be patient” and “listen very carefully” to the market before implementing any further interest rate increases. (1)