• 1971-2004
• A History of Fed Leaders and Rates (1979-2015)
• Effective Fed Funds Rate since 1954

HIGHLIGHTS

• US stocks were up by 0.70%.
• Fed Chair Powell seems to have given the go-ahead to a rate cut later in the month.
• A rate cut in a growing economy, with unemployment at close to record lows, with no liquidity crisis, and markets at all-time highs would be unusual to say the least.
• But it does bring back memories of 1924 and 1998.

MARKET RECAP

Stocks continued their march higher, advancing by 0.70% for the week, as Fed Chair Jerome Powell pretty much confirmed that a rate cut is on the way.

DON’T FIGHT THE FED

Federal Reserve chair Jerome Powell seemed to give the green light to an interest rate cut later in the month in testimony to Congress this week. While Powell did not say that a cut is definitely on the way, his testimony seems to be leaning that way. Powell highlighted risks to the economy including the trade war, a global economic slowdown, Brexit, and an exploding deficit. The idea now for a rate cut would be to reduce the risks of a recession before the wheels of the economy start moving downhill. Powell said: “The bottom line is, the economy is in a very good place, and we want to use our tools to keep it there.”

Usually, rate cuts happen when inflation is moving higher and/or there is visible stress in the economy. And usually, the Fed is starting from a higher base. Not this time. While the US economy is slowing it is still in slow-growth mode, asset markets are priced at all-time highs, the unemployment rate and the initial claims for unemployment are essentially at all-time lows. Liquidity is everywhere. A rate cut in an economic environment like this has harkened back memories to two other similar Fed moves.

New York Fed Chair Ben Strong cut rates in May, June, and August of 1924 to the lowest rates that were ever set by the Fed. The cuts were not in response to a weak US economy, but rather, to help Britain attract gold back into their country. The cuts led to a wave of speculation. The Fed eventually raised interest rates back to 4% but cut again in March of 1926, not because of a weak economy (the economic outlook was good), but because of a 9.1% sell-off in the Dow. Fed Board member Adolph Miller, the only dissenting vote, said this is “the most costly error committed by it or any other banking system in the last 75 years.” That led to more speculation and eventually the 1929 crash, helped along by a huge trade war (Smoot-Hawley tariff).

In 1998, the Fed reduced rates from 5.5% in September to 4.75% in November and would keep them flat until the following summer when they began to increase rates again. The Fed cut was in response to the Asian financial crisis, a Russian debt default and the near-collapse of the hedge fund, Long-Term Capital Management. The US economy was in good shape at the time, inflation was low, US equity markets were close to all-time highs, and markets were liquid. The market kept right on rising until the crash of 2000.

Time will tell what happens down the road, but for now, the age-old adage of “don’t fight the fed” appears to be the rule of the day.

SCOREBOARD

Highlights of an interview with Robert Wilson, a famous short-seller from the 1960s and 1970s.

Click here.

HIGHLIGHTS

• Stocks move higher by 1.64% on news of a US/China trade truce.
• Some analysts are looking for a big move higher in the market.
• A stronger than expected payroll report.
• While stocks have moved higher, earnings estimates continue to fall.
• The ISM PMI continues its decline, now at 51.7.

MARKET RECAP

Markets barreled higher this week as US stocks increased by 1.64%, led by news of a truce in the USA-China trade war last Saturday. International stocks were up by 0.64% and bonds were flat. With the market at new highs and the advance-decline line increasing, the technical condition of the market looks solid and some analysts are now predicting a big run-up here in the 5-10% range. That might seem optimistic given lower ISM numbers and declining earnings (see below), but the price of stocks is ultimately based on supply and demand, and right now demand is greater than supply, probably helped by falling bond yields around the world.

PAYROLL

One piece of good economic news this week was the jobs report. Nonfarm payroll increased by 224,000, which was much higher than the estimate of 160,000. The better than expected number sent stocks lower by around 1% on Friday (before recovering with just a small loss) as traders worried that a better economy would lower the odds of a Fed rate cut later in July. That is how the market sometimes works in its convoluted way when good economic news is bad market news and the other way around. The unemployment rate did move higher to 3.7% from 3.6%, but that was because of an increase in the total labor force. Year over year wage growth was 3.1% and the average workweek remained unchanged at 34.4 hours.

EARNINGS ESTIMATES

While equities move higher in price, earnings estimates continue to move lower. According to Refinitiv, estimates were revised lower this week for 2019, 2020, and 2021 by 1.01%, 1.37%, and 2.04% respectively. 2020 estimates hit their peak on 10/12/2018 at $195.68, and have since declined by 5.41% to $185.09. Meanwhile, the S&P 500 has increased by 9.8% during that time. That is a divergence that cannot continue forever.

ISM

The Institute for Supply Management’s Purchasing Manager’s Index fell to 51.7. Above 50 is considered expansionary, but the index has been in a downward trend and is now at its lowest level since October of 2016.

SCOREBOARD

HIGHLIGHTS

• US stocks were down, and international stocks rise.
• Stocks wrap up the best half-year since 1997 and the best June since 1955.
• Trump and Jinping declare a cease-fire on trade.
• Falling GDP estimates.

MARKET RECAP

Stocks fell by 0.40% for the week but wrapped up the half-year with a walloping 18.8% gain. It was the best first-half performance since 1997. It was also the best June since 1955, +7.08%. Stocks managed gains so far despite softening economic data around the globe and increased threats of a heightened trade war. Interest rates have plummeted, the 10-year bond closed the quarter at an even 2.0%, down from 2.69% at the start of the year. And the 3-month / 10-year treasury curve remains inverted, at 12 basis points, the most since the inversion started. But none of that mattered as stocks continued higher with a lot of help due to dovish sentiment from central banks and over $13 trillion in global debt yielding less than zero.

For the week, international stocks gained 0.40%, bonds were up by 0.21%, the dollar was flat, and oil increased by 1.81%.

CEASE-FIRE ON TRADE

On Saturday, after the trading week ended, President Trump and Chinese President Xi Jinping agreed to hold off on additional tariffs on Chinese goods. China agreed to buy large amounts of American farm products. Trump also agreed to remove some limits on Huawei Technologies buying equipment from the US.

GDP GROWTH

While stocks are in rally mode, the economy is not. The US clocked first-quarter GDP growth at 3.1%, but the Atlanta Fed’s GDPNow growth estimate for Q2 is only 1.5%, and the NY Fed’s Nowcast is coming in at 1.3%. The Nowcast estimate for Q3 is 1.20%.

SCOREBOARD

HIGHLIGHTS

• A new record high for stocks.
• Trump and Jinping to meet at the G20.
• Powell signals interest rate cuts to come soon.
• Iran shoots down a US drone as oil explodes higher.
• IPO mania continues.
• Gold seems to be breaking higher.

MARKET RECAP

Stocks in the US jumped higher by 2.08% and international equities were up by 1.86%.  US stocks closed at a record high. Bonds were up by 0.50% on lower interest rates, and oil exploded up by 8.83% on increased tensions between Iran and the US.

Stocks were helped by two pieces of news. First, on Tuesday, markets had a big rally when it was announced that Trump and Chinese President Xi Jinping have agreed to meet at the Group of 20 in Japan next week.

Then on Wednesday, the Fed held rates steady but hinted that they would cut interest rates soon. Fed Chairman Jay Powell said, “The case for [a] somewhat more accommodative policy has strengthened.” Powell cited a downturn in global economic indicators and increasing trade tensions as heightened risks. The Fed commentary pushed interest rates even lower, and as interest rates fall, the attractiveness of equities increased, moving stocks higher. The 10-year treasury fell to its lowest level since 2016, touching below 2% before ending the week at a 2.07% yield. Markets now expect up to three 1/4% cuts between now and year-end.

IPO mania continued this week. Slack went public and was up 50% from its opening price estimate.

OIL EXPLODES HIGHER

Oil prices exploded higher as tensions between the US and Iran increased. Iran shot down a US drone on Thursday. And then Trump called off a US retaliatory attack at the last minute. The US is sending 1,000 more troops to the Mideast and Iran said that its nuclear enrichment efforts would soon be in excess of the nuclear accord limits.

GOLD BREAKOUT

A lower US dollar, monetary policy run wild, out of control deficits, possible war with Iran, is enough to finally have pushed gold out of its multiyear slumber, and the metal might finally be breaking higher.

SCOREBOARD

HIGHLIGHTS

• Stocks in the US were up by 0.57%
• A strong retail sales report.
• Executive confidence is declining.
• Industrial production was up in May but still down from December.
• Another hit to free markets as NY implements strong rent control legislation.

MARKET RECAP

Stocks rose in the US by 0.57% and dropped by 0.52% around the world. Equities were helped by successful initial public offerings. Chewy, an internet-based pet-product retailer jumped 59% in their debut. The trade war is still on investors minds, Broadcom reduced its sales estimate by $2 billion this year because of that.

US stocks are hovering around the May 16 price level, which was the last interim high. The VTI has failed to close above that level for five consecutive days (see the orange line below).

RETAIL SALES

Retail sales increased in May by 0.5% with broad-based gains. April sales were revised up to +0.3% from an initial report of a 0.2% decline. The strong report will give the Fed some pause before cutting interest rates. Real personal consumption expenditures (PCE) are increasing at a 3.9% annual pace this quarter. PCE accounts for more than two-thirds of the economy.

EXECUTIVE CONFIDENCE

The Business Roundtable reported that chief executives confidence in the economy fell to the lowest level since Q4 of 2016. And a survey of CFOs from Duke University showed that 69% expect a recession will have begun by the end of 2020.

INDUSTRIAL PRODUCTION

Industrial production was up by 0.4% in May after dropping by 0.4% in April. Year over year, industrial production was 2% higher but it is 1.5% lower than the December level.

NY RENT CONTROL

In another blow for free markets, New York passed rent control legislation that would impact almost one million rent-regulated apartments in New York City or about 40% of the city’s rental inventory. The legislation allows other municipalities to adopt similar regulations. The legislation was more aggressive than real estate industry groups expected and will likely lead to deterioration of apartments over time. Instead, the legislature should have focused on making it easier to develop new housing.

SCOREBOARD

MARKET RECAP

Stocks around the world went into a strong rally during the week. US stocks had their best day in five months on Tuesday after Federal Reserve officials discussed possibly lowering interest rates. The Dow advanced by 512 points or 2.1%. The S&P 500 matched the 2.1% increase and the NASDAQ surged by 2.6%. St. Louis President James Bullard said that a lowering of rates “may be warranted.” Fed Chair Powell said, “We are closely monitoring the implications of these developments for the U.S. economic outlook and, as always, we will act as appropriate to sustain the expansion.” Things got better from there as the market moved up each day. For the week, the US stocks were up by 4.34% and international stocks by 2.78%. Bonds also increased by 0.12%.

TARIFFS

Late on Friday the US and Mexico reached a deal on immigration to avoid Trump’s threat of new tariffs.

PAYROLLS

Nonfarm payrolls were up by 75,000, falling way short of the estimate of 175,000. The much lower than expected number helped raise expectations that the Fed would be more to apt to cut interest rates in the near future, thereby helping to move stocks higher. However, other gauges of the labor market are still strong, including initial claims for unemployment, a historically low unemployment rate (3.6%), higher average hourly earnings (+3.1%), and a steady average workweek (34.4 hours)

GLOBAL GROWTH

The World Bank lowered its growth forecast to 2.6% from 2.9% in January. The estimate for growth in trade fell to 2.6% from 3.6%. “There’s been a tumble in business confidence, a deepening slowdown in global trade, and sluggish investment in emerging and developing economies,” said World Bank President David Malpass. The lower forecasts are directly related to trade conflicts.

SCOREBOARD

HIGHLIGHTS

• Stocks are down by 2.69% in the US and 1.12% outside the US.
• The technical damage begins to add up.
• More trade war threats with China and now Trump adds tariffs to Mexico and threatens more.
• The 3 month/10-year curve is still inverted.
• There are multiple efforts around the world for trading systems that do not rely on the US dollar.

MARKET RECAP

It was another rough week as US stocks tumbled by 2.69% and international stocks fell by 1.12%. Bonds were up by 0.9%. Trade war fears and the impact on businesses and the economy continue to hurt stocks (read below). The technical damage to stocks is starting to add up. The VTI fell below resistance (see 1-3-5-9 below) and the price is under the 200-day moving average. The 50-day moving average is now on a downward slope.

TRADE WAR

Trade war fears continue to rattle the markets. Threats fly back and forth. Chinese media reported that China would consider cutting exports of rare-earth metals that are necessary for some advanced electronic products. China said it would not accept any deal that harms sovereignty and dignity. On Friday, Trump said he would begin implementing a 5% tariff on imports from Mexico, that would increase from there if there is no progress on illegal immigrants passing through Mexico on the way to the US.

Since Trump increased tariffs on China in early May, the market has fallen by x%, resulting in a decline of about $5 trillion dollars in US equities. In the last 30 days, Trump has put in place or threatened, tariffs amounting to almost $200 billion in increased costs on US businesses. That would be enough to cancel out the value of the tax cuts. But worse than that, the tariffs will disrupt supply chains, make businesses more inefficient, lower business certainty and confidence, increase unemployment,  lower profits, and reduce the perception of the United States as a reliable trade partner, among other things. In other words, bad things will happen. And as the tariffs ramp up, and the longer they last, the more damage.

Considering that the US economy was not that strong to start, a tariff war being fought on multiple fronts increases the odds of a recession in the next year or so. Trump may not realize it, but he lowers the chances for his reelection with these foolish policies.

BOND YIELDS

The 10-year yield has fallen to the lowest level since September of 2017 and yields less than the 3-month treasury bill. All recent recessions have been preceded by an inverted yield curve.

BREAKING AWAY FROM THE DOLLAR

The Trump administrations constant use of economically isolating individuals, companies, and countries around the world are increasing the calls for an alternative system that does not rely on the US dollar. Europe, China, and Russia are working on their own bank-transfer systems, and others are also in the works. The net result is that over time the power of the dollar could fade.

SCOREBOARD

HIGHLIGHTS

• US stocks fall by 1.14% on continued trade worries.
• The 3-month/10-year spread has inverted again.
• Trade relations with China continue to deteriorate and Mexico/Canada could be next.
• Weak PMI and durable goods reports.
• May resigns as PM increasing the odds of a hard Brexit.
• Positive news in Japan.
• The Vancouver housing bubble is bursting.
• The ratio of copper to gold is falling.

MARKET RECAP

US stocks fell by 1.14% and international equities were off by 0.27% as trade war worries continue to rattle the markets. The Dow is on a five-week losing streak, the longest since 2011. The bond market was up by 0.35%, as demand for government paper has jumped. The 10-year yield fell to 2.327% and is back to being lower than three-month yields, creating another inverted yield curve.

TRADE

Trade relations with China continue to deteriorate. Not content to freeze Huawei from international markets, the Commerce Department is now putting together a list of other Chinese companies to blacklist. All of this will create long-term harm for US businesses. Going forward, why would any international company choose to do business with a US company, all other things equal, knowing their supplies could be cut off at the whim of a US President? Meanwhile, the White House is having problems getting Congress to approve the new trade deal with Canada and Mexico. If Congress does not approve the deal, Trump could follow through on his threat to withdraw from NAFTA, which would be another heavy blow to the economy.

PMI / DURABLE GOODS

The IHS Markit US manufacturing PMI came in at 50.6 for May, the lowest level since September of 2009. Overall business activity growth fell to a three-year low. “Growth of business activity slowed sharply in May as trade war worries and increased uncertainty dealt a further blow to order book growth and business confidence,” said Chris Willamson, Markit’s chief business economist.

Orders for durable goods fell by 2.1% in April, and the March numbers were revised down. A drop of 25% in civilian aircraft, impacted by the grounding of the Boeing 737 MAX, impacted the numbers.

The combination of weak PMI and durable goods reports has led to lower Q2 GDP estimates. Research firm Macroeconomic Advisers dropped its Q2 estimate to 1.7% from 1.9% and the NY Fed’s Nowcast fell from 1.41% from 1.79%.

BREXIT

Theresa May resigned as British Prime Minister after failing to get a Brexit deal through Parliament. May will remain in office until a replacement is named. Former foreign secretary Boris Johnson is the leading candidate to replace May. Johnson is much more of a hardliner and would be more apt to make a clean break with the EU without a deal. In general, businesses fear the economic shock of a no-deal Brexit.

JAPAN

The Japanese economy expanded at a 2.1% rate in the first quarter, that is up from 1.6% in Q4. The 2.1% also exceeded analysts expectations, who were expecting a flat to a negative number.

VANCOUVER

We have written about the problem with excessive housing valuations in Canada and it looks like the bubble has popped, at least in Vancouver, the epicenter of the excess. Stories abound of expensive homes and condos going for discounts of 25% to 50% off assessed value or recent transaction prices. A quarterly index of prices shows Vancouver values dropping by 14.5% year over year. Land sales were down by 54% in the first quarter.

COPPER/GOLD

The price of copper relative to gold has dropped recently. A falling ratio has been a precursor to some market declines in the past.

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