The Days Ahead: Retail sales and manufacturing numbers
One-Minute Summary Market at record highs. It’s all down to that curious mix of a slowing (not recessionary) economy and lower rates, both here and in the major economies in Europe. Recent numbers on CPI and employment, the two biggest market moving data points, have come in above estimates. The yield curve steepened especially in the 5s/10s, so that takes some heat off recession fears.
Nothing remarkable in the details. Energy did well but that reflects a bounce in the oil price not some big global-growth-demand story. Stocks that did well were health care related and all to do with the ups and downs of the Medicare for All story.
1. What will the Fed do? Cut but not by much. We're writing this just as Chair Powell is wrapping up two days of Congressional testimony and the latest Fed minutes from June are out. We'd summarize the Fed’s position as i) the economy is fine ii) but we can't see inflation anywhere iii) we hear about some bad stuff especially trade iv) an “insurance” cut seems like a good idea and v) that will get the President off our backs. Ok, we made that last one up. But the direction is for easier money.
One interesting note was that Powell’s written piece (here), felt the need to stress the Fed’s independence. Then there was this:
“I urge Chairman Powell and other Federal Reserve Board governors not to submit to the high pressure tactics of this President who continues to push reckless and harmful economic and social policies,” House Financial Services Committee Chair Maxine Waters, a Democrat, told Powell.
She asked Powell what he would do if Trump asked him to resign.
“Of course I would not do that,” Powell said, and repeated that he fully intends to serve his four-year term.
We cannot recall anytime where the Fed has had to state its own independence. I mean it’s one of those things, right? Most economies run independent central banks, no?
We felt it was Chair Powell laying down a marker. Not daring Trump to fire him. He seems too sensible for that. But calmly stating he’s holding his own and not intimidated. Of course, Trump could force the Fed’s hand by going all out on tariffs, inducing a slow-down and recession. The Fed would then cut rates, restoring the economy to health around, oh, say mid-2020. But he wouldn't do that.
We don't feel the Fed will cave nor do we think Trump will force a resignation. We don't think the rate cut is necessary. Employment is fine, inflation low but not heading into dangerous or negative territory. When we look for trouble, we look for depth, duration and dispersion. We see no material, widespread slowdown in any major leading indicator.
The Fed did not surprise the market, so full marks for communicating well. Here’s the 10-Year Treasury:
Yields rose which means the market expected a little more from the Fed and gave up some recent gains. But here’s the 2-Year Treasury:
Yes, it moved in the opposite direction. What’s happening is that i) the long end of the curve was overbought and ii) the front end could move down on the confirmation that a rate cut is coming.
Here’s how the yield curve moved with the blue line as of writing on Friday, compared to a week ago (yellow) and for grins, 18 months ago (black):
What does it all mean? Rates dropping. Long end looking cooked. The 30-Year Treasury popped up. It’s very inflation sensitive. Keep the floaters because we’re getting more coupon than the Ten-Year and stay in the middle of the curve.
2. Top of the market. Should I buy? Yes. One of our favorite analysts, John Kemp, over at Reuters, had some interesting stats as we sail/crawl by the 3,000 mark on the S&P 500.
Here we go, with the S&P 500 going all the way back to 1929.
There’s an upward bias to the stock market. It reflects nominal GDP, inflation and productivity. Even if U.S. industry stopped making any productivity growth, the market would probably rise by 2% just to track inflation. Add in another 2% for dividends and 2% for share buybacks and you're in the 5% range without too much effort.
So, the long-term trend is up and the short-term trend is about the cycle, greed, fear and the thousand natural shocks we’re all heir to.
The S&P 500 has traded at record highs eight times in 2019. In 2018 it was 19 times, 2017 62 times and 2016 18 times. On average, the S&P 500 trades at a record level 13 times a year.
The current trend is not concerning. It’s come on a little fast in 2019, but it was oversold in late 2018. The average return for the last 5 years is 8%, which is slightly more than we use in our plans and projections.
So, yes, you can buy at these levels.
3. How’s the budget deficit going? Ha, not well. The deficit is up 23% from last year and at this rate will hit $1tr, around 5% of GDP by year-end. Receipts are up 2.6% and spending up 6.6%. Interest payments on debt are up 16%... although some of that is due to the Fed running down its QE balance sheet.
The bond market seems not to mind but then the volume of new Treasury securities don’t drive rates much. Inflation and growth do.
We bring this point up because the debt runaway seems not to bother many people in Washington. In the week that Ross Perot died, we recall his charts and warnings when we ran deficits of around $300bn. Now it’s three times that and you don't hear about it. Or as Mr. Perot said:
“The debt is like a crazy aunt we keep down in the basement. All the neighbors know she’s there, but nobody wants to talk about her.”
We also bring it up because the debt ceiling runs out in September and, guess what, there is no agreement on raising it. So, we’ll put a pin in that.
Bottom Line: Earnings season starts in earnest with the big banks all reporting next week. Equities have come a long way. We'd like to see some consolidation.
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--Christian Thwaites, Brouwer & Janachowski, LLC
Please note that this discussion of our investments and investment strategy (including our research and investment process) represents our investments and investment strategy at the date of this commentary, and is subject to change without notice. We cannot assure that the type of investments discussed in this commentary will outperform any other investment strategy in the future, nor can we guarantee that such investments will present the best or an attractive risk-adjusted investment in the future. This is for general informational purposes only; references to an individual security should not be construed as a recommendation to buy or sell that security. The securities mentioned in this commentary are only several of the successful as well as unsuccessful investments by us, and do not represent all of the securities we have purchased, sold or recommended. Although we deem reliable the sources of the statistical and other information referred to in this commentary, we cannot guarantee the accuracy or completeness of any statements or numerical data. Past performance is no indication of future results.
All charts from Factset unless otherwise noted.