How the Fed’s ‘quasi-QE’ helped turn a prominent stock-market bear bullish on cyclicals — for now

  • Written by MarketWatch
  • Published in Economics

Policy makers — namely the Federal Reserve and the White House — may have just succeeded in pulling the U.S. economy back from the brink, clearing the way for stocks, which are the most sensitive to the business cycle, to outperform over the next six months or so, according to a top Wall Street strategist.

Barry Bannister, head of institutional equity strategy at Stifel, offered a prescient warning last year ahead of the fourth-quarter stock-market slump. Bannister held then that the Fed had tightened monetary policy too much and would eventually need to cut interest rates. And even as the Fed moved into an easing cycle this year, Bannister questioned whether the easing would be enough to offset the earlier mistakes and avoid a recession.

Bill Denison
Barry Bannister

Since then, the Fed last month delivered its third interest rate cut of the easing cycle. And more important, it has embarked on what Bannister described as “quasi-QE” as it committed to increasing the size of its balance sheet in response to a rough patch in money markets that saw the central bank briefly lose control of its policy interest rate in September. QE or quantitative easing refers to the creation of banking system reserves by a central bank that financial institutions can then use to buy bonds or other assets, effectively injecting liquidity into the markets.

On the international trade policy front, meanwhile, the U.S. and China are seen moving toward a “phase one” agreement that would address some of the disputes between the world’s two largest economies, taking some of the heat out of the long-running spat.

“The Federal Reserve, by shrinking its balance sheet, and the White House, by pursuing a trade war, skated very close to the edge of the ice and risked a recession. Both are backing off and that’s positive for global sentiment,” said Bannister, in a Thursday interview.

That, along with the lower risk of a no-deal Brexit which could have slowed European economic growth even further, should make for a weaker U.S. dollar as safe haven flows ease, and in turn should help lift oil prices. The lower geopolitical and monetary policy risks are also a positive for the reflation trade which could lift Treasury yields further as nominal economic growth recovers — a boon for financial stocks.

Bannister sees the yield on the 10-year Treasury note TMUBMUSD10Y, +0.38%[1] rising to 2.25%, compared with around 1.91% on Friday. As Bannister declared in an Oct. 13 note, that should favor cyclical sector stocks overall, including financials, energy, industrials, technology and materials. Stifel, in turn shifted away from an overweight position in defensive stocks and bond proxies.

Earlier this week, Bannister built on his positive call, forecasting the cyclical recovery to last...

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