@theMarket: All Eyes on the Fed
It was a week of chop. That was to be expected, given it was the first week of second-quarter earnings results. While some individual big-name stocks made substantial moves, the overall indexes traded up and down but ended the week about where they started.
It was largely what I predicted would happen. The same will apply to this coming week with all eyes intently focused on the July 31 meeting of the Federal Open Market Committee taking place next Wednesday. Investors expect the Fed to cut the Fed Funds interest rate by at least one quarter percent. Let's hope they do.
In the meantime, aside from earnings announcements, investors were confronted with some bad news out of Washington. After months of waiting, the U.S. Justice Department finally announced that the U.S. government has launched an investigation into the largest U.S. technology companies. Specifically, authorities will be trying to determine if the likes of Facebook, Apple, Google and Amazon are guilty of anticompetitive practices. If they are found guilty, that could lead to antitrust charges.
Actually, I was impressed with how well the markets held up given that the above named "FANG" stocks have been the market leaders for years. The four companies represent a substantial weighting in many of the U.S. indexes, such as the S& P 500 and NASDAQ indexes. While no one knows how long until, or even if, any of the companies will ever be charged, the investigation will cast a pall over the group for some time to come.
So, while investors grabbled with the bad news from this Justice department, over at the U.S. Treasury, Stephen Mnuchin, its Secretary, announced some good news. Both he and the White House's Chief Trade Representative, Robert Leigthizer, are off to China Monday to resuscitate high-level negotiations with their Chinese counterparts on trade.
While traders cheered the China news, my own belief is that talks are going to become even more difficult now that China's Trade Minister Zhong Shan has joined their negotiation team. Shan, while regarded as capable, knowledgeable, and professional, is also considered a "hard-liner." As such, he could make discussions even more difficult and probably will. That might fit into the president's game plan.
It is my own belief that Donald Trump does not want a breakthrough deal announced quite yet. One of the chief reasons investors are expecting the Fed to cut interest rates is the fear that an escalation in the U.S./China trade war would cause havoc with our economy. Until there is a deal, that China threat is hanging over our economy.
Trump is keenly aware of this. The president is also on the record in demanding that the Federal Reserve Bank cut interest rates now in order to grow the economy. But that does not mean a recession is looming in front of us. Friday's second quarter Gross Domestic Product (GDP) report came in at 2.1 percent which was above the expected growth rate of 1.8 percent. While consumer and government spending were strong, business investment slowed.
The probability of a U.S. recession over the next 12 months is less than 33 percent, according to research released by the New York Federal Reserve Bank. As such, the Fed's expected interest rate cut next week (if it occurs) is believed to be little more than monetary "insurance" just in case talks break down, in which case, Trump has threatened to then levy another 25 percent tariff on the remaining $350 billion of Chinese exports to the U.S.
If the Fed does cut rates, we will see what the president's next move will be. Of course, that is not entirely within his control, since China will have an equal say in what kind of deal is struck and when. As for the markets, enjoy the ride, but be aware that some time soon we could see another 5-7 percent pullback.
@theMarket: Looking Ahead
Will the second half of the year be as good as the first half for the markets?
The S&P 500 Index finished up 18 percent for the six months ending June 30. That was the best first half since 1997. Historically, that kind of return is three times the gains investors can normally expect from the market in an average year. The chance of a repeat performance in the next six months is, at best, remote.
That doesn't necessarily mean this is as good as it gets for stock investors. My near-term target for the S&P 500 Index is somewhere around 3,050, which is a further 4 percent gain from here. From my vantage point, as long as interest rates continue to decline and the Fed stays at least neutral, we go higher.
For the time being, the China trade tariff worries are off the table. As I predicted last week before the G-20 meeting, Donald Trump adhered to his "speak loudly, but carry a little stick" foreign policy. He relented on a number of issues, including holding off on any further tariffs on China, at least for the time being.
While the markets rallied on Monday as a result, they quickly gave back their gains since investors are beginning to learn that not everything that our president says will necessarily be accurate, or when it is, his statements are almost always an exaggeration of reality. The Fed, on the other hand, is a different kettle of fish.
You might ask why the markets are continuing to rise when economic growth here and abroad continues to slow. First, recognize that the economy and the stock market are two different entities. What may not be good for Main Street (slowing employment gains, sluggish business investments, weakening quarterly earnings), in this case, increases the chances that the Fed will cut interest rates as early as this month and that would be good for the markets.
At this point, despite the Fed's refusal to confirm or deny an interest rate cut, the financial markets are convinced they will cut. The odds of a Fed interest rate cut by July 31 have surged to 100 percent. While 72 percent of traders are counting on a quarter-point cut, almost 28 percent of traders are expecting a half-point cut. That in itself is astounding, since the Fed has not cut rates by that much in many years. Over 60 percent of bond traders are also counting on another rate cut as early as September, according to CME Fedwatch.
Whenever the markets are unanimous about anything, I usually feel the hairs on my neck begin to tingle. Given that the stock markets are climbing, based on that interest rate assumption, it behooves the investor to ask what will happen if everyone has it wrong and the Fed doesn't cut? The short answer would be look out below.
And as we close out this holiday-shortened week, remember that when we get back second-quarter earnings season will be upon us. Right now, consensus for second-quarter earnings results for the S&P 500 is a scant 0.2 percent. Third quarter estimates are not much better ( 0.7 percent gains). What is concerning to me is how corporate managements are going to spin the impact of the existing tariffs on their bottom line.
In past quarters, analysts have ratcheted down their earnings expectations to such a low levels that investors were pleasantly surprised when companies announced better than expected earnings and sales guidance. It could happen again, so let's say I am neutral on earnings results until we see how many beats versus misses happen early on.
In any case, it appears the administration is bringing out the Big Guns to pressure the Fed into cutting rates this month. Don't underestimate Trump's ability to influence events in that area. Trump believes that the Fed should be his policy instrument and an extension of his presidential power in the financial arena. He has already threatened to fire, replace, or demote the Fed's Chair, Jerome Powell (his appointee), several times.
In a further attempt at bringing the Fed under his control, this week Trump has proposed two more additions to the Federal Reserve Board, Christopher Waller and Judy Shelton. Both candidates appear to be far less independent than past candidates for the job. One of the two (Shelton) has already expressed a desire to see interest rates in the U.S. at 0 percent within the next year or two. That should be music to the ears of the president.
In any case, enjoy the markets, enjoy the Fourth of July, and I'll see you after the holiday.
@theMarket: G-20 Weighs on Stocks
It wouldn't be a normal weekend in the financial markets without something to worry about. This weekend, it is the meeting of the two presidents, Trump and Xi, in Japan with $350 billion in new tariffs hanging on the outcome. What are the odds that they clinch a deal?
Not great, in my opinion. That doesn't necessarily mean that we need to brace for a worldwide economy-killing deluge of massive tariffs and counter-tariffs either. There is too much at stake for Donald Trump and China knows it. Instead, I expect we will get a classic Trumpian foreign policy "speak loudly and carry a little stick" maneuver.
Robert Lighthizer, our U.S. trade representative, already telegraphed just such an outcome earlier in the week. After a conference call on Monday with his Chinese counterpart, Vice Premier Liu He, several unnamed trade officials indicated that "the U.S. is willing to suspend the next round of tariffs on an additional $300 billion of Chinese imports while Beijing and Washington prepare to resume trade negotiations."
So sometime over the weekend, I expect one of those "my great friend, Xi, and I agreed to further talks, so I will delay implementing these new tariffs" kind of statements from the president. Of course, there will be the usual bluster about how much tariffs will hurt China and how we are making so much money on existing tariffs already, yada, yada, yada.
If my expectations are fulfilled, the markets should once again breathe a great sigh of relief. Stocks will likely rally. The economy will probably continue to slow. I expect businesses will continue to postpone investing while consumer prices on tariff-impacted goods will continue to rise.
Everyone (except Trump's wild-eyed loyalists) realize by now that the existing tariffs are hurting the economy, slowing employment, raising prices and causing more and more distress among the nation's farmers, manufacturers, and technology and retail companies. This year, we should see the largest one-year rise in tariffs since the Smoot-Hawley Tariff of 1930, which precipitated the Great Depreciation.
At the same time, the Fed's Jerome Powell, while acknowledging that the tariffs are hurting the economy, continues to hedge his bets. On Tuesday, he indicated that, contrary to Wall Street's expectations, a July rate cut was not a done deal. That was enough to send the markets lower just as the Dow Jones Industrial Average was about to join the S&P 500 Index in making a new historical high.
All of this week's jitters, however, is simply noise that you, the long-term investor, should ignore. Stocks had a great run last week and needed a pullback. It is that simple, and given the unpredictable nature of our president, pullbacks are increasingly becoming a dime a dozen. We can expect the S&P 500 Index to find support somewhere around 2,875. From where I sit, that simply clears the runway for another major leg up in the markets.
There is always an outside chance that I have it wrong. Could Trump do another "Kim Jong Il Walk Out" like he did in Vietnam a few months ago? If he does, or simply fails to cut any kind of deal (a low probability event in my view) then look out below. Markets will swoon, but at that point we should expect to see a central bank rate cut in July, which would support the markets.
@theMarket: Stocks Should Move Higher From Here
It was a good week for investors. The S&P 500 Index hit an all-time high. The Fed indicated that they might cut interest rates sometime soon, and the President is once again optimistic about a China trade agreement. That’s a heady cocktail that could see markets gain another 3-5 percent over the next few weeks.
Of course, the critical caveat to my forecast remains President Trump's next tweet on the progress of a trade deal with China. As you know, with such a big “if” on the table, making future forecasts with even a modicum of certainty is impossible.
In last week's column, I enumerated all the scenarios that could play out, but it really comes down to how much faith an individual has in the president's ability to pull-off a deal with China. And while a successful agreement would definitely be good for the economy over the long term, I am not so sure it would be beneficial for the stock market.
My concern rests upon the Fed's reaction (or lack thereof) if an agreement is put in place. Chair of our Federal Reserve Jerome Powell has hinted that cutting interest rates would largely depend on what happens next on the trade front. That has sent the stock market to new highs.
The Fed reasons that additional tariffs of the size contemplated by Trump would impact our economy by over one half of one percent. That would be on top of a U.S. economy that is already slowing, thanks to the existing level of tariffs, and the rhetoric of even more actions if things don't go the president's way. Under those circumstances, one, two, or even three rate cuts could be justified by the Fed.
On the other hand, if the economic pall of trade sanctions were to be removed from the world's economies, there would be few, if any, reasons to cut interest rates. In fact, if global growth picked up as a result of a trade deal, an interest rate hike might be the better policy. Of course, that won't sit well with a President who expects to be re-elected on the back of a strong stock market and economy.
"Let's see what he does," warned Trump, when asked about the future of Jerome Powell. Trump would like interest rate cuts now to back-stop him (and the economy) if the G-20 meeting with President Xi Jinping blows up in his face next week. In the event the meeting is progressive, and chances of a deal improve, Trump wins (in his mind) on all fronts. A stronger economy, a higher stock market, and a campaign promise almost fulfilled.
From the central bank's point of view, doing the president's bidding now before the certainty of a trade deal, opens up the possibilities, in the medium-term, of an over-heated economy, a spike in inflation (that may be difficult to control), and a Pandora's box of subsequent economic dislocations down the road.
Despite the pressure from the White House (firing or demoting him if he doesn't cut rates now), Powell, while sounding dovish, managed to avoid cutting rates this week, not that the market expected him to. He couched his language with just enough promise to satisfy Wall Street and mollify the President.
The markets anticipate 2-3 interest rate cuts between now and the end of the year; so does the president. By maintaining a wait-and-see attitude despite, the fact that almost half of the Federal Open Market Committee members are urging a rate cut, Powell is between a rock and a hard place.
My bet is that next week, the Trump/Xi meeting goes well. There will be more negotiations, but no deal. The markets will like it. The economy will not, and thus should continue to slow. That will set up the Fed to cut the Fed Funds rate by a quarter point in July. The tension, the wall of worry, the negotiations, and the atmosphere of uncertainty swirling around the president's next tweet will continue throughout the summer. That should be good for the market and your portfolio.
@theMarket: Markets Expect Fed to Cut Rates
Investors can credit the Fed once again for the market's revival thus far in June. The buying is fueled by expectations of three rate cuts by no later than December. Is that wishful thinking?
While only 23 percent of investors expect a rate cut next week when the Fed meets, 83 percent do expect a cut in July. The odds of another cut in September are now at 63.8 percent, with a third cut in December, which is expected by over half of market participants.
Given that the Fed's job description is to keep inflation under control, while supporting robust employment, one or the other of those variables will need to change in order for the Fed to cut rates. The inflation rate is still below the Fed's stated targets, so that shouldn't be the issue, which leaves jobs as the area of concern for the Central Bank.
Over the last few weeks, job creation has slowed down, but so far the data does not indicate the unemployment rate is set to skyrocket. It is true that warning signs are flashing for economic growth both here and abroad, but the U.S. is still expected to grow by 2.2-2.5 percent this year. Most economist models indicate a further slowing to slightly under 2 percent for the U.S. economy in 2020, but that still results in an acceptable performance for an economy that is on its 10th year of expansion.
I guess the real issue that makes forecasting by the Fed, investors, and myself so difficult is the ongoing trade and tariff threats that will most likely decide the fate of the global economy. Three rate cuts might be justified if the two antagonists (Trump and Xi) meet at the G-20 at the end of June and fail to compromise. The kind of tariffs Donald Trump is threatening to levy on China would certainly put a big dent in global trade and shave a half percentage or more off the U.S. economy next year, if not sooner.
On the other hand, if the two agree to disagree, but continue to negotiate through the summer, corporations would still be living on borrowed time, but won't invest. Our farmers and other exporters would continue to try doing business within the continuing status quo of uncertainty. That sort of atmosphere, while not a robust business climate, might not be sufficient enough to justify a rate cut by the Fed.
In this land of the unknowns, therefore, we are left with throwing the bones and/or reading tea leaves to come up with all sorts of what-if's. Story lines like "Donald Trump needs a China deal, otherwise, the economy slows, the stock market plunges, and he loses the 2020 Election."
Then there is the China sub-plot: "China's game plan is to procrastinate until after November 2020, or at least wait until the economic pain in the U.S. is such that Trump caves-in and is willing to strike a better deal than he is offering now."
If one looks at the action in the bond market, where interest rates have fallen to multi-year lows, the consensus seems to be gloom and doom. But that is nothing new--bond investors are a gloomy mob even at the best of times. If you look at the stock market, which is only a few percentage points away from historic highs, you could say that the future is rosy and there are blue skies ahead. Which is right, since they can't both be correct?
Maybe it simply comes down to whether you are a half-empty or half-full kind of investor. Donald Trump is definitely in the camp of those that believe the stock market should go higher. If that means the Fed should cut interest rates and be dammed the consequences, then so be it!
In the other camp are those who get hurt when interest rates fall. Retirees, pension funds, and all those who shun undue risk in exchange for a steady income. While those voices do not appear to be well represented in today's environment, they do represent a sum of money that dwarfs that of the equity market. Yet, they also have the reputation for being smarter than equity investors and are right more times than they are wrong.