Know the Environment
"The enlightened ruler is heedful, and the good general full of caution."
"Where absolute superiority is not attainable, you must produce a relative one at the decisive point by making skillful use of what you have."
--Carl von Clausewitz
What Do We Know?
On the surface, an easy question to answer. That said, there are many layers of depth that must be fully understood before we move on.
We know that U.S. economic growth peaked in mid-2018 and has softened somewhat since, though far less dramatically than previously thought. We also know that there are several pertinent downside risks to economic growth to our nation's immediate to short-term front.
1) A below-target consumer level inflation is spoken of most often. Voting members of the Federal Open Market Committee (FOMC) have made clear that they are fully cognizant of this condition as there has been a dramatic shift lower in their range of expectations for 2019 personal consumption expenditures (PCE) both at the headline and the core; they are just a few steps behind nearly early single person in finance.
2) There is serious risk posed by global, developed economies that are decelerating faster than that of the U.S., forcing external central banks to guide toward easier monetary policies ahead of, and more quickly than, the Federal Reserve, while starting from a lesser point in the first place.
3) This slower growth abroad has pressured the long end of the U.S. Treasury yield curve at precisely the same time that the FOMC had been pushing short-term yields higher while also drawing liquidity out of the economy, a profound policy error at the time that forced that yield curve to badly invert, not to mention increased late 2018 market volatility.
4) Corporate earnings growth, pressured by trade policy, will not only slow but also can be expected to contract further. According to FactSet, S&P 500 second-quarter earnings are expected to show "growth" of -2.5% on downwardly revised year-over-year revenue growth of 3.9%. This is with the S&P 500 trading at an aggregate 16.5x the next 12 month's projected earnings. That price-to-earnings (P/E) ratio means the S&P 500 is trading precisely at its five-year average in terms of valuation.
5) Activity across the manufacturing base appears to be slowing somewhat in terms of New Orders, Unfilled Orders, Inventory Building, and perhaps even employment. Compounding this condition is the uncertainty that is present, as well as short- to medium-term corporate pro-activity now made necessary as companies (including small businesses that have been so optimistic) move to adjust supply chains, pinching margins.
6) Voting members of the FOMC have made clear that they understand these conditions, not only by virtue of their lowered expectations for inflation, but also through changes made in the June policy statement from the May statement. The excerpt "In light of these uncertainties and muted inflation pressures, the Committee will closely monitor the implications of incoming information for the economic outlook and will act as appropriate to sustain the expansion." speaks volumes. In my opinion, that line makes the decision of July 31 a very live one.
What Don't We Know?
I think the quick answer is, "More than I will ever know, even if I keep on learning... even if I keep on striving." That said, let's tape on the foil, let's button down those jerseys, and let's get after it.
1.) China. How big is the "extended meeting" between Presidents Trump and Xi at the coming G-20 summit in Japan next week? I think that the best possible outcome is a limited deal meant for media (and algorithmic) consumption that really solves very little. The facts are that President Trump faces re-election, and President Xi sits atop an economy that is apparently slowing rapidly. Both leaders need to show progress and may cooperate in order to get this done.
That said, I would not bet the farm just yet. The risk of tariffs being placed on another $300 billion of Chinese exports to the U.S. is very real, and even at a reduced rate of 10% would impact financial markets in the most severe way, as this would not just accelerate China's decline, but also that of corporate America (including labor markets) and the rest of planet earth as well.
2) Iran. A few months ago, I might have typed "North Korea" instead. The point I am trying to make is that geopolitical risk remains enormous, especially now that so many nations have access to -- even if methods of delivery might be limited --nuclear-type weaponry. I am sure most of you know by now that Iran's Revolutionary Guard shot down a U.S. Navy drone over international waters overnight. You want to know where the next Black Swan event is? Yeah, I don't want to know, either.
3) June Domestic Macro Data. Now that we know that Retail Sales and Industrial Production for April were actually much better than feared, second-quarter GDP projections have greatly improved. Job creation finally slowed in May. Now, we spoke of corporate earnings above. Understand this: If the macro erodes from here, any slowing in small business, purchasing manager activity or even homebuilder confidence will further pressure capital expenditures, and that includes labor markets. There is no "maybe" about this. Once labor markets are pressured, so goes consumer confidence. As a nation, we still skate on the preferred side of the ice, but the ice grows somewhat thin.
You know, this is not our first rodeo. The Federal Reserve Bank intentionally has signaled a U-turn in its trajectory for monetary policy without overtly panicking. Futures markets trading in Chicago now price in a 100% chance of an reduction to the fed funds rate in July, with a 32% chance of a cut of 50 basis points at that time. That larger cut is fully priced in by September. There is now, according to this market, a 27% probability that the fed funds rate, currently 2.25% to 2.5%, will stand in a range of 1% to 1.25% by April 2020.
Equities-- really, most asset classes -- do well at least at the onset of a move by the central bank toward easier policy. At least that's what the book says.
Can it be different this time? Of course it can. Though we do like the pro-activity and not simply waiting first for the data to force action, we also understand there is less room to play with than ever before when embarking on a policy shift. Thanks to the experiences witnessed across both Japan and the eurozone, we now know that negative rates have been a complete failure in terms of promoting risky behavior. Such policy forces defensive posture at the personal level and puts the entire financial sector in jeopardy. Will the Fed be smart enough not to go there? We can only hope. They've never wowed us before.
You did not ask. Therefore, I may not have the right to opine. So, instead of offering advice, I will tell you how I will go about my business. The answer is, "Like I always have." I trade my book. I remain overwhelmingly net long. I still like the cloud and aerospace names that I have written about. So many stocks now run with great-looking charts, now that market indices will at least approach all-time highs on the opening bell. Target prices and panic points. Hit for singles and doubles.I will allow home runs to come to me, but not try to hit them. Exposure to gold? Of course. I'm not changing a thing.
We do not know what next week (G-20) or even tomorrow will bring. Laugh the extra laugh. There are certainties. We live. We die. We face and rise above adversity at all times. That is who we are.
We do not fear. No need for that. Ever. Our stories have been written in stone for a thousand years. Even stone eventually becomes sand. When we are long gone the only thing that will have mattered will be that we have loved each other, and helped each other. Help the ones to your left and to your right. Help the one who needs a friend. I am here. The slowest among you shall not walk alone this day. Now rise.
Economics (All Times Eastern)
08:30 - Philadelphia Fed Manufacturing Index (June): Expecting 12.0, Last 16.6.
08:30 - Initial Jobless Claims (Weekly): Expecting 219K, Last 222K.
10:00 - CB Leading Indicators (May): Expecting 0.1% m/m, Last 0.2% m/m.
10:30 - Natural Gas Inventories (Weekly): Last +102B cf.
Today's Earnings Highlights (Consensus EPS Expectations)