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