For almost a decade the bulls rooted for signs of economic strength from the U.S. economy. That's because they knew that as we climbed out of the Great Recession the Fed would have to start tightening from what amounted to zero interest rates. Given how low rates were when the hikes started it was reasonable to believe that we could have a strong economy despite the Fed's actions. Without it, we would have earnings disappointments and stocks would go down. The bears would win if the economy were too weak.
That's all changed now. Everything has changed ever since the Fed blinked Tuesday and Fed Chair Jay Powell said he is monitoring the economy to try to avoid it getting too weak. And for the many people who only know that good data is, well, good, meaning robust commerce is good for the stock market, this moment must be so confusing because the bulls are now eager for weakness. How can the stock market rally on a very weak ADP payroll report as it did Wednesday morning? How can slow housing sales be good, or anemic auto sales be great?
In other words, how can bad be good? How can a market cheer for weakness after longing for solid growth for so long?
It's easy: we are now on the other side of a rate cycle, one where the Fed has tightened too much and bulls must hope that economic activity is slowing enough that Jay Powell will reverse course from his last hike in December and start cutting rates. It's a Bizarro world, like the villainous DC Character who liked 'em ugly and wanted to put arms on Venus de Milo. Anything that is weak is a positive to be excited about and anything strong is a nightmare because that might stiffen Powell's resolve to keep rates where they are instead of cutting them.
Just today the averages were flying high because of the possibility of a weak non-farm employment number from the Labor Department, on the heels of the precursor ADP number.
The stocks took a breather and reversed when the Fed released its Beige Book that showed some decent growth in most of its 12 districts. I don't want to be too pejorative but so often the Beige Book has gotten the state of the economy wrong. It did mention that there could be some weakness in retail and industrial coming because of the tariffs but, overall, it was too positive and didn't fit the new storyline.
What does? What is the market keying on?
First, after watching a market that had been totally hostage to the price of oil rising for many years as a sign that stocks should go up the bulls now want oil to fall as it did Wednesday.
I know it seems ridiculous to root for oil to go higher given that it is a tax on the consumer and industry, but that's what we were doing for ages around here when the tightening cycle was game on. It was a demonstration that the market could handle ever higher rates.
Now, weakness in oil, weakness like the clobbering we had Wednesday justifies a rate cut. The bulls do not question whether oil is going down because of excess supply, which is something I believe is propelling oil down. I keep thinking about that terrific interview we did with Pioneer Natural Resources' (PXD) CEO, Scott Sheffield, about how the Permian is producing an amazing amount of oil right now. About a decade ago when the U.S. was producing five to six million barrels a day Sheffield came on Mad Money and said that number would double by the turn of the decade. Sure enough, we are producing 12 million barrels a day. Now he says we will soon be producing 17 million barrels a day. That's going to wreck the oil market, which is already showing signs of cracking as it's officially entered into a bear market Wednesday, down 20% from its high.
But that excess supply doesn't matter to the big thesis. For those who are looking for signs of weakness, plummeting oil is Exhibit A about why the Fed can't wait. It must cut now.
Exhibit B? The tariffs. The president may be convinced that tariffs are good for the American people, because whoever gets slapped with them does the paying. That's how he can be so excited about putting tariffs on China. He believes we have nothing to lose and everything to gain for doing so because the tariffs help cut the deficit. You are not going to convince him otherwise.
But the Fed? It's concerned that tariffs are slowing our economy, that they are making execs pull in their horns and consumers hoard their cash. Jerome Powell is worried, for example, if there's a rising tariff against Mexico that starts on Monday consumption will be crimped especially because Mexico produces so many cars. The president thinks he's got a twofer going: the Mexicans pay for the wall and companies that make cars in Mexico will be disadvantaged versus cars made in the U.S. Again, he sees no negatives to it. The Fed, on the other hand, knows that consumers will get strapped if these tariffs start going up at the same time as we slap at least a ten percent tariff on the rest of the goods we import from China. The president is tariff happy. The Fed is petrified.
Final exhibit? The bond market itself. The 10-year rate has collapsed. It's too low versus the Fed's mandated short rates and that's a sign that the central bank is way off the mark with the rates that it sets. The Fed is conscious that such an inversion is a sign that the economy is about to rollover. It doesn't want a recession on its hands but the low 10-year rates are a sign of a lack of demand whether it be for money for construction or for new mortgages.
The Fed's totally cognizant of how wrong it is right now, so wrong that many observers expect a rate cut in July if not before that. I don't think the Fed will. Too early from when Jay Powell was crowing back in October that we might need three rate hikes this year because the economy was way too hot. Wow, was that ever an ill-advised prediction.
Now you can see the bets being made every day that we are going to have a recession. That's what's behind the huge moves we have seen in, say, PepsiCo (PEP) , Kimberly-Clark (KMB) and Hershey (HSY) . They don't need a strong economy to do well and given the slowdown in commodities they are actually able to make far more money per Frito or Kleenex or chocolate bar because they aren't going to reduce their prices, which have been rising forever just because their raw costs are coming down.
Stocks such as those of Salesforce (CRM) , Adobe (ADBE) , Okta (OKTA) and so many other cloud investments can keep doing higher because we are in a deflationary environment and yet those companies are secular growers that don't need a strong backdrop to make their numbers.
But make no mistake about it, the higher the tariffs, the lower the rates and the harder oil falls, these all give the Fed reasons to cut rates. It needs the reasons; the president has pressured Powell endlessly to cut rates. The Fed chief needs the cover and the slowing economy is giving it to him.