In digestion

In digestion.  Stocks closed mixed yesterday, giving up earlier gains as investors digested the Fed’s latest policy change.  Now that the market got what it wanted in a rate cut, traders are wondering when the next one will come.

 

MY TWO CENTS

 

1.  Which economy are we talking about?  Everyone seems to be obsessed with the economy these days!  **That was a joke, people SHOULD be focused on the economy.  But the big question is, what about the economy should we focus on?  How about growth of Gross Domestic Product?  That seems to be a good start.  Once a month the Bureau of Economic analysis releases GDP figures for the past quarter revising them each week and ultimately culminating in the official number.  The number is broadly watched and often quoted.  But doesn’t it seem somewhat suspect that we are focusing on an estimate of the performance of the economy from last quarter… as in the one that ended just before we celebrated Independence Day?  Ok, you get the point.  We need to focus on drivers of economic growth.  Things such as consumption, inflation, business optimism, and consumer confidence, to name but a few.  We can also pay attention to guidance provided by companies.  Companies provide guidance to the Wall Street analyst community to minimize volatility in their stocks.  You heard that right.  The market does not like surprises, so companies would rather give some clues about what to expect in the coming months, good and bad.  “What is their incentive to be accurate and honest,” you ask.  Well the last person you want to upset is the analyst that covers your company.  They are tasked with projecting future earnings, the stock price, and future prospects for the company and they like to be right.  Surprising your analyst is the quickest way to get a downgrade, which almost always spells trouble for a stock.  Turning back to the stream of both public and private economic releases we get (and I report here) throughout the month, there are economists and macro analysts that are tasked with predicting those as well.  Unfortunately the government doesn’t provide guidance like companies, so the likelihood for surprises is much higher.  A number of organizations track economic surprises and the most followed is the Citigroup Surprise Index.  The index tracks actual economic releases versus expectations with positive readings meaning that numbers have been stronger than expected, and vice versa.  The index peaked at its highest positive level since the financial crisis in late 2017 but quickly descended throughout 2018 going between positive and negative through most of the year.  In 2019, the index spent most of its time in the negative, meaning that economic numbers were coming out weaker than expectations.  Since hitting lows in June, the index has been slowly improving and went from negative to positive earlier this week.  So actual numbers are coming out stronger than expected.  Yesterday, OECD (The Organization for Economic Cooperation and Development) came out with its projections for global economic growth and cut its 2019 global projections to the lowest level since 2009.  They revised growth projections for the US downward from 2.8% to 2.4% for 2019, and from 2.3% to 2.0% for 2020.  With no guidance on those numbers and increasingly positive economic surprises, one wonders if OECD itself will be surprised if their estimates are wrong.

 

2.  Perfect balance.  I have been reporting a lot on the small off-the-beaten-path issue that the Fed is tackling in the overnight money markets.  The Fed, for the first time since 2008 has had to intervene in the open markets with overnight repo facilities.  That is the technical term for it, but it really means that they are buying bonds and thus providing liquidity, or cash to banks so that they have more of it to lend at reasonable rates.  Remember, more supply means lower price (I know that I repeat it over and over, but it is critical to understand the concept).  I reported earlier in the week that the open market activity is normal for the Fed but they haven’t had to do it in many years as the markets have been efficient enough on their own.  Funding markets can get really tight in response to two principle things: 1) technical reasons such as a quick spike in demand for overnight funds to pay for bond purchases, or 2) When there is trouble, such as the collapse of Lehman Brothers, where a major lender suddenly dropped out of the market crushing supply and causing the repo market to seize up.  Thankfully here, it is a technicality that caused the spike in overnight rates.  The Fed has been quite active this week, adding about $75 billion in liquidity each day, in an attempt to normalize rates.  The results of their activities have begun to bear fruit as overnight rates have since retreated.  In his speech earlier this week, Chairman Powell spoke about the “organic growth of the Fed balance sheet”.  Remember that when the balance sheet grows it means that the Fed is buying securities in the open market, which can be stimulative to the economy.  Many Fed watchers interpreted his words as hinting to future quantitative easing.  Some analysts now suspect that the Fed may announce some sort of QE program in their next FOMC meeting in late October.    For now though, the balance sheet will continue to grow as the Fed injects money into the open market in order to keep rates within their target range.

 

THE MARKETS

 

Stocks closed mixed yesterday as investors began to wonder about what the Fed might do next and shifted their focus back to a potential trade deal between the US and China.  The S&P500 was unchanged, the Dow Jones Industrial Average closed down by -0.19%, the Russell 2000 sold off by -0.44%, and the NASDAQ Composite Index advanced by +0.17%.  Bonds climbed slightly and 10-year treasury yields fell -1 basis point to 1.78%.  Crude oil traded up by a nominal +0.03% after falling over -7.5% in the two prior sessions following its epic +25.68% climb on Monday.  Oil has had quite a week, and the volatility will continue.

 

WHAT’S NXT

 

– New York Fed President John Williams, San Francisco Fed President Mary Daly, and Dallas Fed Head Robert Kaplan will all speak today.  Pay attention.

– Baker Hughes US Rig Count is expected to have gone down to 880.67 from 886 this week.

– Next week, we will get manufacturing PMI, some more housing data, Consumer Confidence, GDP, Durable Goods Orders, PCE Deflator, and The University of Michigan Sentiment Indicator.

– Today is Quadruple Witching for US markets and the S&P500 will rebalance, which will most likely make for a high volume session.

 

Have a great weekend!

daily chartbook 2019-09-20