Federal Reserve Chairman Jerome Powell served his job well this week as he made a rather dovish whatever-it-takes-to-sustain-expansion comment in Chicago to get the oversold S&P 500 and Nasdaq market to bounce off their key 200 day moving average support levels. A market that is clearly confused and awash with tons of liquidity (algorithm and speculative momentum trading strategies), chasing it in either direction hoping to catch the "real" trend. It is quite ominous to see markets change from extreme bearishness to bullishness in a matter of days, usually synonymous at key inflection points. It is important to take a step back and see what is happening across asset classes to understand whether or not the rally makes sense or has legs.
Let's reassess. In May markets touched all-time highs as there was hope of an imminent trade deal as per President Trump's daily tweets. The Fed was rather relieved as they could carry on raising rates and normalizing their balance sheets - the logical thing to do given the incredibly low interest rates and ballooned balance sheet in place since the last financial crisis. Trump then decided to throw a wrench in the works by going gangbusters on China as he was not getting his way, which spooked the market as they had completely priced no risk for the Trade Wars. We have been past peak expansion since 2018, one of the longest recovery cycles seen.
Trump has but one agenda: get the S&P 500 to the highest level possible to be able to claim a victory despite how fragile the U.S. economy is. The Fed's agenda is to make sure that the market does not collapse or be responsible for bursting the bubble, but in doing so, it is making it worse for the longer run. The more the market is addicted to lower interest rates and quantitative easing, the worst it will be for the market to go into rehab and recover. It is truly addicted to free money.
There is no doubt that the global economic data is showing serious signs of stress. This is apparent in Global PMI surveys printing below 50 and ISM data showing contraction not only in the U.S. but also in Europe. We are on the verge of a recession no doubt. According the Fed Funds futures, there is a 70% probability of a rate cut by July and 100% probability of a rate cut by year end 2019. The bond market is seriously inverted with yields collapsing further with the U.S. 10-year yield trading at 2.08%. The S&P 500 was back at 2875, only 2.5% off its all-time highs after falling to as low as 2750. What gives?
U.S. May Payrolls printed today showing jobs were up 75,000 vs. expectations of 175,000. In addition to the May slowdown, the April numbers were revised lower to growth of 224,000 vs. 263,000 previously. The unemployment rate has remained at 3.6% (lowest since December 1969). Wage growth slowed a bit in May, printing at 3.1% from 3.2% in April. How can the Fed possibly justify cutting rates with wage growth the highest in over a decade and the labor market so strong with S&P 500 close to all-time highs? It is like committing suicide.
Bond, equity and rate markets cannot all be right. Something has to give. At times like this, one needs to understand why markets are rallying than be overtaken by greed. This week the rally was nothing other than a short-term bounce, as algos turned massively short as charts were broken. They then switched to full bullish mode as they went back up threatening to regain the 100-day moving average. This u-turn has coerced investors to sell at lows and buy at highs.
Since Powell's speech, it is only the S&P 500 that rallied from its 2750 lows with select technology stocks like Amazon (AMZN) , Microsoft (MSFT) , and Adobe (ADBE) doing very well as their earnings were quite stable and positive. Quality always rallies before value. Laggards such as semis like Micron (MU) and Alibaba (BABA) are still trading weak given their exposure to China.
Copper has not rallied at all. Mining stocks are still at their lows. Global Oil inventories remain bloated.
The yuan/dollar is still flirting with the key 7 level, especially as the PBOC made a comment this morning that they are not married to the 7 level, implying if need to they are willing to let it devalue more. If the Yuan breaks the 7 level, it is a guarantee that markets will be alarmed and commodities will get crushed on further devaluation fears.
There is a difference in closing your shorts and going long for an oversold bounce trade. Going long here is another matter altogether. One must not be fooled by the tape, but be wise enough to see what is driving markets higher. If one is unable to explain it, it is best to sit on the sidelines and wait it out.