Trump, Tweets, and Tariffs
Anyone else dizzy?
It was down Monday, Surge Tuesday
From the Bleachers, Vol. 23
The S&P 500 melted up last week, beginning its surge on Tuesday after a down day on Monday. The index rose 4.4% on the week, finishing at 2873.34, above its 200-day moving average once again. Monday was down (as expected) after the market closed below the 200-day last Friday and at its lows. Monday’s low was 2728, a number to remember because the market will. (We will likely see 2728 again in the coming weeks or months). Tuesday saw the S&P 500 gap up at the open and climb higher throughout the day. There was a late push through 2800 and a successful close above that important number to cap off Tuesday’s surge higher. The S&P has now crossed 2800 nineteen times since January of 2018.
The media ascribed the sharp Tuesday rise to comments emanating from various Federal Reserve officials. On Monday, St. Louis Fed President James Bullard was quoted as saying, “a downward policy rate adjustment may be warranted soon to help re-center inflation and inflation expectations at target.” Fed Chairman Jerome Powell followed up on Tuesday morning with dovish comments about future monetary policy, made at the start of a two-day Fed conference in Chicago. The quote that seemed to get investors excited was made while Powell was referring to trade talks and “other matters,” during which he said that “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, with a strong labor market and inflation near our symmetric 2 percent objective.”
Recall that we wrote last week that a more dovish Federal Reserve might cause a near-term change of market direction. Specifically, “In the absence of some further indication from the Fed that it is prepared to ride to the rescue with rate cuts, it is more than a little likely that we will see new lows in the stock market for the current downtrend in the coming weeks as the economic data continues to soften.” We may, of course, still see new lows for the current downtrend in the coming weeks, but speculators may be able to ride the wave of “lower-interest-rates-are-coming” euphoria for a week or two before the weakening economic fundamentals reassert themselves.
Regardless, the S&P 500 is likely to continue its rise Monday morning, given Trump’s tweet Friday evening that tariffs won’t go into effect with Mexico due to an agreement on border security. Or will it? After all, the removal of a tariff threat to one of our largest trading partners might, counterintuitively, have investors selling on Monday in the belief that the Federal Reserve is now less likely to cut rates in the near-term. Anyone else dizzy yet?
As for the near-term direction of the Federal Funds rate, the market is now pricing in two rate cuts by December with the likelihood of a rate cut by the July meeting currently at 85.6%, according to the CME FedWatch site. Furthermore, the CME site shows a 90.8% chance of a rate cut by September. Perhaps it’s worth reminding ourselves that rate cuts are usually initiated because of a faltering economy, which in turn threatens corporate earnings. As a result, two risks face investors currently: First, the economy is slowing sufficiently to warrant Fed rate cuts, which may mean disappointing corporate earnings in the back half of 2019. Second, the economy isn’t slowing sufficiently to warrant Fed rate cuts. The second risk is a risk because the stock market is, as of last week, pricing in rates cuts, which, if they fail to materialize, could easily send investors running for the exits a month or two from now.
Regardless, the longer term drivers of market direction continue to point toward a stock market that will struggle to advance meaningfully. Corporate earnings are expected to drop 2.8% in Q2 and be flat in Q3 before rising 7% in Q4. Backloaded earning growth is always a risk to the market since that earnings growth doesn’t always materialize, especially when the economy is slowing, as it has in Q2. Real Q2 GDP growth of around 1% is likely based on various indicators, plus an allowance for the fallout due to the China Trade War. The latest jobs report certainly doesn’t help the recession camp; job growth was only 75,000 according to the Friday report, more than 100,000 below expectations. Downward revisions of 75,000 in the two prior months mean no job growth at all over the last three months. As well, the World Bank has cut its 2019 global growth forecast to 2.6% this year, compared with the 2.9% estimate it made in January. Global growth below 3% is a recession, according to the International Monetary Fund (IMF), and has happened six times since 1970.
All in all, the risk of recession in the U.S. continues to rise. The likelihood of Fed rate cuts in 2019 also continues to rise. The probability of a retest of the 2728 Monday low is quite high and risk management for investors with spending plans (that require selling investments) remains the order of the day.
Christopher R Norwood, CFA
Chief Market Strategist