What does a record stock market signal for our economy?

By: Pierre G. Villere

In late June and early July, the stock market indexes all rallied to new, all-time highs, capped off by a surging Dow Jones Industrial Index that closed at a record high on the day before Independence Day. This came about as trader sentiment, whether it is the retail day trader or the institutional investor managing billions, strengthened over what appears to be a thawing on the issues of both tariff negotiations, as well as the general trade picture.

The Dow was the last of the three major indexes to notch a record this year, as trade tensions, concerns of slowing economic growth and problems among individual companies such as Boeing and 3M weighed on its performance in recent months. The trade truce spurred the latest leg of the Dow’s recovery after the U.S. and China reached a pact that eased investors’ fears of an all-out trade war between the world’s two biggest economies. But the cease-fire only put additional tariffs on hold indefinitely, leaving investors concerned that lingering frictions could give way to another flare-up in trade tensions and market volatility. But baked into the market’s new highs are another expectation: a cut in interest rates.

As I have written previously, the Fed has moderated its stance on the interest rate picture. First, it signaled no further rate increases in 2019. Then, after examining the metrics that drive the interest rate decision process, they signaled further that a rate cut might be in order as certain indicators demonstrated weakness in some sectors of the economy. One that jumps out is the concern over the health of the auto industry, which predicts U.S. new-vehicle sales this year are likely to fall short of the 17 million mark for the first time since 2014. But the reason is pretty simple: analysts feel the Great Recession extended the replacement cycle for American consumers and businesses alike, and now a protracted run of strong sales following the financial crisis has satisfied pent-up demand.

It is these indicators in major industries like autos that have the Fed concerned. The Fed is not tight; the federal funds rate is currently 2.375 percent, and no one can say this interest rate is keeping anyone from making an investment. Of more important note, every prior Fed-induced recession happened because the Fed withdrew reserves from the system, pushing up interest rates. It was the lack of money—the squeeze on reserves—that pushed interest rates higher and caused recessions.

Rates themselves don’t cause recessions; it’s the reason rates move that really matters. Today, the Fed still has $1.4 trillion in excess reserves in the system, so it can hardly be called tight by any stretch of the imagination. It is when the Fed withdraws too many reserves, pushing the federal funds rate above the pace of nominal GDP growth, that the economic tides turn toward recession. So how close are we now? Over the past two years, nominal GDP is up at a 4.8 percent annualized rate, twice the current federal funds rate.

Jerome Powell and the Fed governors are watching the metrics carefully, and our firm is convinced a rate cut comes in the weeks or months ahead, further spurring the stock market indexes—and the economy. This will serve to further bolster consumer sentiment, as the indexes are an easy economic indicator to point to. So further upward movement in the indexes, spurred by an expanding economy combined with an expected interest rate cut, assures continued growth for construction at large, and concrete volume in particular.

Pierre G. Villere serves as president and senior managing partner of Allen-Villere Partners, an investment banking firm with a national practice in the construction materials industry that specializes in mergers & acquisitions. He has a career spanning almost five decades, and volunteers his time to educating the industry as a regular columnist in publications and through presentations at numerous industry events. Contact Pierre via email at [email protected]. Follow him on Twitter – @allenvillere.