Federal Reserve head Jerome Powell chaired the May FOMC meeting yesterday evening, keeping rates unchanged, but his commentary was rather more hawkish than most participants would have liked. President Trump asked (rather demanded) the Fed to cut interest rates by 100 bp. Clearly his view is to re-lever the economy to oblivion and raise as much debt as possible, as long as the equity markets are higher into his re-election campaign, to show how he "Made America Great Again." Stupid enough voters would rather believe his sensationalist commentary than actually think about the state of the U.S. economy and their cost of living, instead of asset prices.
Going into the May FOMC meeting, it was rather dubious why market participants expected a 70% chance of a rate cut in 2019. One wonders, with employment close to full, labour market so strong, and economic data stabilizing, that there would even be a need to cut rates. And it would be career suicide for a Fed chair.
Inflation is one of the Fed's key measures -- and it is trailing their 2% target. But Powell did say that this is "transitory" and expects inflation to be higher. One of the comments made by Powell was that the key risks from earlier this year had moderated, namely weak global growth, Brexit uncertainty, and U.S./China trade risks. One begs to ask, if the above risks had moderated and economy stabilized, then why retain the patient stance? After all, last year at this time with the S&P 500 trading at more or less the same levels, the Fed was reducing its balance sheet, as well as raising rates accordingly, to rid the economy off of its excess liquidity over the past decade. Why hold off now?
The Fed dropped the IOER rate, but that was just a technicality as the Fed Funds rate spiked recently above the IOER. The market's initial reaction was to bid up bonds and equities and sell the dollar -- they missed the point entirely. During the FOMC press conference, Fed Powell's commentary made a lot more "rational" sense. He stated that he did not see a case for either a rate hike or a cut -- they are buying time. Their commentary was very supportive of the growth and risks abating. Baby steps? If the market and economic data continues this way, surely the next step would be for a rate increase, not decrease. He also said "asset prices are elevated, but not extreme."
As the entire world is obsessed with the level of Nasdaq 100 Index (NDX) and S&P 500 Index (SPY) , which really is down to only a handful of stocks, no one has bothered to see what is happening to the "reflation" trade. Copper had a false break above $6600/tonne only to reverse sharply and fall all the way down to $6200/tonne -- a 6% fall in a few days. Mining stocks are down about 5%-10% from their highs.
The growth picture is deteriorating and commodity stocks had been priced to perfection assuming a bounce back in global growth, along with U.S./China trade wars subsiding. The latest headline from President Trump suggested that if he did not get his way, he would be willing to walk away. The trade representatives are meeting this week and ironically, during Powell's press conference, a headline appeared saying a "deal was possible by next Friday." Call me a cynic, but it seems Trump and U.S. officials have learned how to game the market.
End of April marked the peak of the steel demand season, as well. With higher iron ore prices, steel margins are lower. Output will start to fall in the next few months -- unlike in the first quarter. This should cap steel stocks. The copper market is finally balanced here, but with speculators long and the USD rallying as growth starts to look a bit uncertain after China's liquidity injection done, it seems the risk is to the downside for now.
Oil price is fully valued, with Brent above $70/bbl. As seen in the recent DOE data, U.S. production is at record highs. OPEC will start to increase production going into June. China and India have said they will continue to import oil from Iran. There is no shortage of oil in the market. Oil equities, namely the majors, have been in a perennial decline as they underperform oil on the way up and on the way down. Other than a dividend play for income funds, these stocks are a source of shorts in one's portfolio.
The sector showing the most growth and lucrative earnings is technology. But this sector is up 25%-40% from the lows. Not all stocks managed to beat earnings. With the Nasdaq on the verge of threatening its uptrend and momentum slowing, perhaps it is a good time to lock in those profits and await a better entry point in select technology stocks.
Investing is all about risk reward. The rationale I get from most investors putting money to work today is "There is No Alternative." This is the worst possible argument to justify entering the market today, because there is no yield evident anywhere. Greed compounded by FOMO makes a toxic cocktail for disastrous performance.