Monthly Markets Memo - July 2019
by Dan Zalipski, CFA
Stocks and bonds are typically thought to offset each other, when one struggles the other is expected to help pick up the slack. Seeing both move higher can be puzzling, but that’s exactly what has happened over the past month. Equity indexes are hitting all-time highs, and the bond market surged with prices moving higher as yields declined. Much of this is tied to both trade and an expected interest rate cut from the Fed.
We covered both topics in last month’s Market Memo, but a lot has happened in the past month. Due to these recent developments and their potential to influence the markets, we feel it is important to continue focusing on these two topics.
As you may recall, the trade issue with China (and briefly with Mexico) saw tensions flare in May. This created a bit of volatility within the markets throughout that month. As we rolled into June, Fed President Jerome Powell managed to calm the markets by acknowledging the situation, indicating the Fed would act appropriately to prevent the uncertainty of the trade issue from derailing the expansion. Further relief was gained towards the end of June as President Trump met with Chinese President Xi at the G20. There was no escalation of tariffs, negotiations resumed, and President Trump partially reversed the blacklisting of Chinese telecom giant Huawei. The Chinese reportedly agreed to purchase more U.S. agricultural products.
Late in the month of June was the Federal Reserve’s FOMC (Federal Open Market Committee) meeting where changes in monetary policy are typically announced. The Fed did not make a change to interest rates at this meeting but continued to signal a willingness to act in order to sustain the current expansion should the economics continue to deteriorate.
Fast forward a few weeks, Fed President Jerome Powell testified to congressional committees that the central bank is very likely to cut interest rates at their July FOMC meeting. The market is pricing this in as a sure thing despite the recent rebound in several economic reports. The jobs report for June surprised to the upside, adding 224,000 jobs in the month far exceeding the 160,000 analysts had forecasted. Inflation, of which the Fed has expressed concern over being too low, came in higher than expected during the month. Both retail sales and factory output within the U.S. exceeded expectations for the month as well.
While these positive developments make it difficult for the Fed to cut rates, other pockets of the economy are slowing in a way that justifies the Fed’s expected rate cut. Housing continues to struggle as new home sales slow. Finally, the Atlanta Fed’s GDPNow estimates that Q2 GDP is sitting below 2%, further supporting the idea that the economy is in a slowdown. The official read on Q2 GDP will be released on Friday, July 26th.
A Fed looking for a weakening economy to greenlight rate cuts may need to look no farther than this earnings season. The consensus is that earnings growth will be -3% for the quarter, marking the second consecutive quarter of negative earnings growth, also known as an earnings recession. So far, 88 companies within the S&P 500 have issued negative earnings guidance. If that number stays at 88, it’ll be the second highest number of companies issuing negative guidance since 2006. There is, of course, the possibility that there will be enough positive earnings surprises to push the year over year earnings growth back into positive territory.
The market has priced in a rate cut in July to the extent that the greatest risk would be the Fed does nothing. Every bit of positive news makes that decision that much more difficult. The more the Fed cuts during times of economic strength means the less they can do to stimulate during times of economic weakness.
“The more the Fed stimulates when the economy is in a good place, the more it will be seen as succumbing to undue pressures from markets and the White House. This could damage its credibility and undermine the effectiveness of its future policy guidance.”
- Mohamed A. El-Erian, Chief Economic Advisor to Allianz
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