A Mixed Bag

A mixed bag.  Stocks had a mixed close yesterday after the Fed lowered target interest rates but would not commit to anything beyond.  The Fed’s move was expected by the market but many were hoping for more stimulus, if at least a sign.

 

MY TWO CENTS

 

  1.  The great divide.  There were great expectations leading up to yesterday’s FOMC meeting.  Futures showed that the market priced in a high probability that the Fed would cut key interest rates by -25 basis points.  The FOMC did, in fact deliver on those hopes.  But the futures don’t always tell us the full story.  They do give us a clue as to what the funds markets are pricing in but they can’t tell us about what traders are hoping for.  Recall the markets’ weakness in the final days of 2018 when sentiment was at its lowest point.  Also, recall that the Fed, specifically Chairman Powell’s words rescued the markets as he shifted his stance and pledged to do what was necessary to keep the economy growing.  His words alone sparked a rally that persisted through late Spring.  All the while, more and more economic numbers began to show signs of weakness.  The global economy slowed from the Eurozone through China but stocks remained healthy.  Why?  Because the Fed continued to pledge its support, creating confidence amongst investors.  Then came summer and some new tariffs, a weaker Eurozone, and Brexit.  Stocks slumped.  The Fed finally made its move lowering rates by -25 basis points in late June.  Despite a few days of volatility, the confidence from the Fed helped stocks regain their footing and propelled them to fresh highs.  See the correlation?  Sure the US and China have been making some progress in the trade battle and earnings have been respectable, but there is still quite a bit of uncertainty in certain sectors in the economy while Europe and Asia continue to show weakening economies.  Investors do not like uncertainty and the Fed seems to be the key component in maintaining investor confidence.  Yesterday’s rate cut and policy statement were exactly what the market expected.  What they really wanted was assurance that stimulus was going to keep flowing and, unfortunately, that message was unclear.  In his statement, Powell spoke glowingly of the resilience of the US Economy: moderate growth, record low unemployment, low inflation… the regular stuff.  All things are good, so why cut rates?  Well he mentioned weakness in US manufacturing, global economic weakness, and trade war uncertainty.  The Fed thinks that a rate cut is “appropriate” given those transient factors.  They also signaled that there was no policy shift.  In other words, these moves are minor adjustments and do not represent a continued program of stimulus.  After all, the economy is doing well (according to the statement).  To put a finer point on things, yesterday’s decision included three voting members dissenting with 2 voting to keep rates unchanged and 1 voting to cut rates by -50 basis points.  What’s more, the Fed released their dot plot which shows FOMC members’ projections for rates going forward and it showed that, on average, they expect rates to remain unchanged for the remainder of 2019 and for all of 2020.  Far from a confidence booster.  In yesterday’s note I wrote about the liquidity squeeze occurring in the money markets in which the Fed had to inject liquidity into the system by conducting repos.  Though they haven’t done it since 2008, it is perfectly normal and is, in fact a large part of the Fed’s responsibility.  Though  the reason’s for the squeeze may be technical and short term, the Fed will have to continue to operate in the open market to keep rates down and within their target ranges.  Another tool to inject liquidity into the system is for the Fed to purchase bonds in the open market.  Sound familiar?  That is quantitative easing.  Powell mentioned that the Fed may consider that if needed in order to keep liquidity in the system.  Stocks liked the sound of that, rallying off of lows into the close.  Or perhaps it was the chairman’s glowing description of the US economy.  One thing is for certain, the path of interest rates in the future remains well… uncertain.

 

  1.  Collateral damage.  The trade war is taking its toll on companies, like it or not.  I have spilled a lot of ink on the topic and why tariffs ultimately hurt everyone.  It is not conjecture, but economic fact!  So far, tariffs have been largely focused on products that are higher up in the supply chain such as raw materials, commodities, and sub assemblies.  Because of this, manufacturers have been able to eat most of the cost increases despite their effects on profitability.  At some point though, manufacturers will have to raise prices in order to stay healthy, which will ultimately cause price increases for consumers.  Earlier in the summer as the trade war escalated, new tariffs were launched which were focused more heavily on consumer products leaving no doubt that price increases will be coming to a Best Buy near you real soon.  But what about all of the other damages caused by the trade war.  In China, an annual report of the countries top brands showed Apple tumbling from the 11th slot to the 24th in the past year while it enjoyed the 5th position before the trade war.  China is an important market for Apple and a loss of loyalty there will certainly diminish future growth prospects for the company.  On Tuesday, Fedex announced results, missing on both revenue and earnings.  Why?  The CEO made it clear that the trade war has seized up trade not only between China and the US, but also between China and Europe.  Fedex lowered its future outlook and the stock fell -9.2% in yesterday’s session.  On the bright side lower interest rates, which have caused a decline in mortgage rates, may be helping the housing market out of a slump.  Yesterday both Housing Startsand Building Permitsbeat expectations with solid monthly growth.  Housing Starts surged by +12.3% compared to last month’s revised drop of -1.5% while permits rose by +7.7% compared to last month’s revised growth of +6.9%.

 

THE MARKETS

 

Stocks closed mixed yesterday in a muted response to the Fed announcing a -25 basis point rate cut.  The S&P500 advanced by +0.03%, the Dow Jones Industrial Average climbed by +0.13%, the Russel 2000 fell by -0.63%, and the NASDAQ Composite Index slipped by -0.11%.  Bonds advanced and 10-year treasury yields fell by -1 basis point to 1.79%.  The yield curve flattened somewhat yesterday as short maturity yields climbed with lowered expectations of future rate cuts.

 

WHAT’S NXT

 

– Philadelphia Fed Business Outlook is expected to be 10.5 down from last month’s 16.8.

– The Leading Economic Index  is expected to have retreated by -0.1% after last month’s growth of +0.5%.

– Existing Home Sales are expected to have dropped by -0.7% after growing by +2.5% last month.

– Darden Restaurants will announce earnings before the bell today.

daily chartbook 2019-09-19

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