Yesterday, stocks halted a two-day losing streak. A late afternoon rally helped shares finish near their best levels of the session. Attacks against tankers in the Persian Gulf helped to lift the price of oil stocks which have been in steep decline lately. The bond market was fairly quiet, and both the economic and corporate calendars were light. Inflation data this week generally reconfirmed that inflation continues to run slightly below Fed target rates. While softness in recent economic data and low inflation could be the catalyst for a Fed rate cut announcement next week, the more likely outcome would be for the Fed to hold rates steady while voicing concern that continued softness could justify a rate cut at either the next meeting at the end of July or the following meeting in mid-September.
The FOMC meeting next week will come in front of the G-20 meeting where Presidents Trump and Xi could meet to discuss trade and tariffs. It isn’t the Fed’s job to predict whether or not tariffs will be implemented and, even should that happen, their impact will depend on the extent that we place higher tariffs on Chinese imports. The Fed reacts to market forces. Tariffs are just one. At the moment they seem important. But how they flow through to consumers via higher prices, and the impact they may have on overall demand in the U.S., is conjectural at the present time. Thus, there are fairly good arguments to wait until July (or later) to take actual action while, at the same time, letting investors know that the Fed is watchful and concerned about recent economic softness.
As I have been noting, with stocks now close to levels first reached nearly a year and a half ago and revisited both last fall and this spring, for prices to move meaningfully to new highs, investors either have to presume that interest rates will continue to fall (along with inflation expectations), or the outlook for corporate earnings will have to improve above current consensus for next year. Upcoming second quarter earnings could give stocks a lift if results are favorable. In addition, consensus expectations will move up or down with changing values in the dollar. At current levels, the translation impact of foreign earnings will have a much less dramatic impact than they did during the first half of 2019.
Three macro issues currently dominate the market:
- Fed policy changes
- The 2020 election.
Fed Policy: I just spoke to that point and additional comment is necessary. Fed Chairman Jerome Powell has said repeatedly that he is data dependent. One can fuss about recent trends, but there doesn’t appear to be a dramatic move in the economy in either direction. With hindsight, the Fed in late 2018 was probably too concerned with rising inflation prospects, and a good case can be made that one or both of the second half rate increases were not needed. If the yield curve at the short end remains inverted through the summer, at least one rate cut would become likely. But I don’t see Fed action materially changing the economic needle any time soon. Growth is falling back toward its normalized 2% path that it has been on since the recession. One-time items, like changes in tax rate, a sharp change in the value of the dollar, or expanding fiscal policy clearly can raise or lower the rate of growth over a relatively short period. But there aren’t a lot of economic imbalances in the system. So Fed policy changes should be subtle and their impact modest over the next 12 months.
Tariffs: The President believes strongly that tariffs or the mere threat of tariffs gives him substantial leverage. Sometimes the threat is enough. He clearly got Mexico to at least state that it would work toward slowing the flow of migrants to our border while under threat of tariffs. We will know better in coming months whether that promise can be fulfilled. China is likely to be a bigger and more lasting economic threat. Some tariffs are already in place. Both Trump and Xi proclaim great respect and a working relationship with each other. But to date there has been little concrete progress toward improving treatment of intellectual property and allowing American companies easier access to Chinese markets. Most likely progress will come in stages. China needs to have open world markets for its exports, and U.S. businesses want access to the world’s second largest marketplace. Economic opportunity is the greatest catalyst to promote cooperation and find common ground. It won’t be easy. Both sides will be resistant to change. But over time there should be erratic movement in the right direction.
2020 Elections: Democrats haven’t even had their first debate among themselves, and there are 24 candidates to choose from including centrists and far left progressives. Ignoring personalities and social agendas, the investor class worries about earnings and interest rates. At this point, we hear many more sound bites than facts. It should be quite obvious that the more extreme options are hardly likely to become law, but any movement toward greater government control and more taxes may unnerve markets sporadically over the next 12 months. Any real movement, however, is likely to await the real campaign after both conventions, and after we know the actual nominees. Fringe freshman members of the House may make firebrand speeches, but they won’t be the candidates. Ultimately the election will focus on a few key states like Pennsylvania, Michigan, Ohio and Florida none of which will likely embrace extreme changes from current policy. Thus, for now, I think the election impact is still not front and center although it will become a larger threat over the next 12-18 months.
The bottom line is that there is little reason to expect stocks to break out from current levels any time soon unless (1) the Fed takes a materially more dovish stance than currently expected (e.g. cuts rates next week and suggests one or two more cuts could come soon), or (2) big tariff news, good or bad, is announced.
Today, President Trump is 73. Boy George is 58. Do you think they ever celebrated together?
James M. Meyer, CFA 610-260-2220