Stocks finished lower both on Friday and for all of last week. Early strength, tied to hopes that the Fed would cut the Fed Funds rate by 50 basis points next week, were squashed when the Fed officials who hinted at the possibility, said such a discussion was only theoretical, and didn’t apply to possible action at the upcoming FOMC meeting.
This week will be a big one for earnings, mostly concentrated tomorrow, Wednesday and Thursday. 133 S&P 500 companies are set to report this week including 10 components of the Dow Jones Industrial Average. So far, about ¾ of the companies reporting have met or exceeded expectations. While some feared that forward-looking guidance might be somewhat dour given the recent slowdown in economic growth, that doesn’t appear to be the case so far. The banks have pointed to consumer strength, citing solid loan demand and very good credit card spending. About the only big miss in the first week of earnings came from Netflix. A combination of the lack of new blockbuster shows in the quarter and a price increase across several major markets led to much lower than expected growth in net new subscribers. These have to be viewed as company specific causes. While competition in the streaming world is clearly about to increase, overall spending on streaming is only going to rise. From a broad economic viewpoint, that is all that matters.
Tensions over the weekend in the waters of the Persian Gulf have put a bit of upward pressure on oil prices. Forty years ago, the price would have spiked, but today world supplies are more geographically diversified and, to date, the actions, while an escalation of recent events, still haven’t closed the Strait of Hormuz and traffic is still pretty close to normal. Obviously, Iran wants some relief from sanctions and is using provocation to get its way. So far, it isn’t working. At the moment, we don’t seem close to an event that would have significant economic impact (e.g. close the Strait entirely), but clearly this bears watching.
The other major theme overriding the market today is the continued worldwide growth slowdown and the efforts of central banks to combat that by further easing monetary policy. The Fed and other central banks can’t force spending, but by making rates lower or funneling more money into the market, they can make more spending appealing. The risks, of course, are that all the easy money won’t stem the growth slowdown, in which case a recession looms. That, however, is a big risk. When businesses hold sales, customers generally come and spend. The only issue is how deep a discount might be necessary to clear inventory.
The other major open matter in Washington is the negotiation between Nancy Pelosi and Steven Mnuchin regarding Federal spending over the next two years, combined with an agreement to raise the debt ceiling. Congress goes into a six-week recess shortly. The Treasury could run out of money without an ability to raise additional debt just about the time Congress comes back into session. At the moment, it appears that both are confident that an agreement for a 2-year spending authorization can be passed. However, similar to two years ago, the talk (few have seen any actual documents yet) seems to suggest another massive spending increase to make both sides happy. The President wants more money for defense and border security; the Democrats want more money for their social agenda. The easy way out, giving both sides what they want, has dangerous long-term implications because of the accelerating deficit. Even at current low interest rates, interest expense will soon exceed defense spending. If rates rise, even a little bit, that could quickly get out of hand. And Congress can’t legislate lower interest costs. The monies to service the debt has to come from somewhere else. Two years ago, President Trump threatened to veto the spending authorization bill but relented and signed it at the last minute. He vowed never to do that again. Now, of course, he is potentially back in the same place. So far, he has had little to say, leaving it to Pelosi and Mnuchin to make a deal. Pelosi is certain to face opposition from her progressive wing but not enough to scuttle the deal. Thus, as the week comes to an end, Mr. Trump is going to have to make a decision. He could sign the bill saying he doesn’t really like it. He could threaten a veto, send everyone into a tizzy, before getting a very slightly better deal. Or he could simply refuse to sign the bill. Should that happen, the fall back is to go back to the limits set in 2011. That would involve significant cuts to the planned level of spending both for defense and non-defense. It would have no impact on entitlements. At the moment the numbers being floated around suggest spending more than $300 billion above the austerity spending governed by the 2011 laws. Many conservatives favor going back to those levels. Certainly, from a debt management perspective, that makes sense. If, however, you want to look at near-term GDP growth, $300 billion less spending would be a headwind to growth.
The probable outcome is for something in between. How that evolves over the next 5 days will be crucial. For markets, the resolution could be more impactful than the corporate earnings reports.
Today, Prince George is 6. Ezekiel Elliott is 24. Don Henley is 72. Danny Glover turns 73. Finally, Alex Trebek turns 79.
James M. Meyer, CFA 610-260-2220