Fed Chair Jerome Powell has certainly proved himself with the ultimate power of his words -- perhaps he could become a fifth member of Marvel's Fantastic Four? It is astonishing how just a few words from Powell back in January, saying "they will do whatever it takes," helped the S&P 500 market rally off of its 2400 lows.
Then once again in March, and just last week, his words helped it rally 200 handles to a new all-time high. Is this a New World Order of monetary policy? I suppose it is a lot healthier than printing more and more, just the promise of it.
Rightfully so, as until today it evaded me to see why people are hell-bent on assuming the Fed will cut when the economy is still chugging along at close to 2% GDP growth (annualized Q2 GDP forecasts), unemployment is at record lows and wage growth is solid. History is a great guide, but investors are too doped up on the slogan "the market can never go down."
Investors certainly suffer from a case of selective hearing, as the Fed June FOMC press conference implied a rather hawkish tone, not a dovish one. And yet, the market rallied. As explained, technical factors are great at influencing market direction, but from time to time, traders just make up whatever narrative suits them -- in blissful ignorance.
On Tuesday, Powell and James Bullard, the St. Louis Fed President, made comments at the Council of Foreign Relations, saying that although "there is greater uncertainty about trade" and they are concerned about the global economy (meaning Trump is making a mockery of the system and rocking the boat for no reason), they are not sure if there is need for a 50-bps cut in July (meaning the market is at all-time highs, why on earth would we cut so much now?).
The job of investing has become more of a "read between the lines" exercise than actual analysis, implying the Fed does not want to pull the only trigger it has now lest there be a bigger collapse later on (aka 2008).
The market may be hitting an all-time high, but the breadth of the market has not been very positive. Banks, the transport sector and small-caps have been trading below their 200-day moving average, and trading lower in this market rally. The last time this happened two times in 40 years the market was lower by 15% in two months.
Let's take a look at earnings, the real reason why any market should or should not rally. the second-quarter 2019 earnings snapshot released by Factset shows the S&P 500 down 2.6% year-over-year. If this is in fact the case, it will be two straight periods of negative year-over-year decline since Q1 2016. Earnings revision for the quarter since they were computed last time on March 31 have been even lower, with the materials and technology sectors now estimated to be down about 13%. Wait, remind me again, where most of the money is parked in this rally. Technology? D'oh!
The S&P 500 market has failed around the 2950 level three times in a row. Two reasons have been cited for the latest surge back up to highs: an imminent trade deal at the G-20 meetings and the Fed cutting rates forever. It seems the market never learns from tracking baseless tweets of "positive talks," as the underlying issue is still at odds.
Deal or no deal, China has started preparing for Plan B and the global supply chain may forever be changed. China knows it cannot and will not let it be dictated by the U.S. -- or anyone for that matter. It is too big of a consumer to try and bully. Senior admin officials announced that no trade deal was to be expected at the G-20, and that sealed the turnaround in the markets during the day.
It's the classic chicken-and-egg scenario. Trump wants the Fed to cut rates and keep printing money forever to get markets even higher into 2020 -- to show his mark as a good President. The Fed can only "justify" this if markets collapse or data gets significantly worse. So, Trump plays his little part and angers China/the world economy to make sure economic data gets even worse, giving Fed the ammunition. Be careful what you wish for, as once the dominos fall, both parties may get more than what they bargained for.
Another bullish reason why investors think the market is cheap is because U.S. 10-year bonds fell below 2% for first time last week. The last time U.S. Treasuries were below 2% (between 2012 and 2016), equity valuations were at the best at these levels in 2016. Lower rates benefit equity valuations as the discount factor is lower, spitting out a theoretically higher asset value. But if rates are lower for the wrong reasons (lower growth and/or recession) or fall too low (deflation), asset values do not move higher; Japan is a prime example of this fact.
Alas, the economics studied over the years comes in handy after all, the power of diseconomies of scale. At some point, lower and lower rates will tip the balance over and be negative, not positive for equities.
Since 2018, most asset classes have been trading with the same theme, with correlations closer to 1. We can pat ourselves on the back by calling us "relative value" or "alpha-generators," but let's be honest, it has been just about calling it one way, up (growth) or down (recession). The theme going into the second half is long the dollar, short bonds via long (TBT) (2x levered) or short (TLT) (underlying instrument), short copper and China-exposed base metals, with oil to track them but break away a bit due to seasonality of demand in the summer. This unwind should see lower equity market levels.
Perhaps the Fed will get the justification it needs in July to give the market a cut, but the market has to play ball too.