Stocks finished mixed yesterday with a slight downward bias. The modest net changes, however, disguised the fact that about 100 stocks rose or fell by more than $4 per share. This is a thin market, especially when everyone wants to buy or sell the same security at the same time. Perhaps the most interesting name yesterday was Alphabet# which fell by about $30 per share after a mixed earnings report. The prior session, it was up $30. Go figure. One could argue that more volatility with overall directional movement is a negative indicator. With stocks one day into new record territory, at least as measured by the S&P 500, there are reasons to be apprehensive, although the VIX, an index related to volatility, remains very low around 13.
While earnings will still be front and center today, the focus will shift this afternoon to the Federal Reserve. Two things are virtually certain. First, the FOMC is likely to cut rates by 25 basis points down to 1.75%. Second, President Trump is likely to bash the Fed for whatever it does short of taking rates to zero. Beyond that, however, there will be an ongoing debate about how far lower rates need to go to stabilize both economic growth and inflation expectations.
One school of thought suggests that rates need to go lower to stimulate growth in a fragile economy. With inflation still largely absent, the argument suggests that the risks associated with lower rates is much less than the risk of doing too little and watching economic growth wither away and morph into recession.
The other school says 2% growth and inflation close to 2% is pretty much ideal. Now that the yield curve is no longer inverted, why not pause after today’s cut and assess whether there is need for more. As you might guess, I support this view.
Very simply said, financial markets do best most of the time without outside interference. Certainly, there are times when liquidity needs or financial crisis mandates action. But now simply isn’t one of those times. World currency markets are relatively stable. Most economies are growing. Worldwide growth is still close to 3%. I understand the pressure from the President who would like even faster growth in an election year. As a real estate guy whose empire is built on debt, lower rates are always preferred. But it is becoming increasingly clear that incremental changes in interest rates are not having the same impact they had in the past. Negative rates throughout Europe, which are exerting a downward pull on our rates and an upward tug on the value of the dollar, simply have lost most of their positive impact. Once rates go negative, any incremental gain from going more negative is either miniscule or non-existent.
That doesn’t mean markets won’t react negatively if Fed Chair Jerome Powell suggests at his post-meeting press conference that the Fed is leaning toward a pause before taking further action. Equity investors are addicted to low rates. Low rates mean high P/E ratios which, in turn, mean higher stock prices. Many, therefore, will be disappointed at any notion that rate cuts are done, at least for now. But these traders are just that, traders. They aren’t necessarily investors looking longer term.
However, in the end, it is the longer-term course of our economy and those overseas that will dictate the future course of earnings. Central bank policy isn’t the only influence. Tariffs and fiscal policy matter as well. But central bank policy is important and can’t be ignored.
The facts today suggest that any slowdown in growth rates is ebbing. Granted there are still weak pockets in manufacturing and energy but the consumer is still employed, taking home more pay, and spending it. As long as that is the case, our economy and most economies around the world will be in good shape. Obviously, they would be in better shape if tariffs are reduced. But that is outside of the control of the Fed.
Bottom line, this afternoon’s trading is likely to be volatile and highly dependent on what the Fed says and how Mr. Powell says it. He doesn’t always do the best job of messaging, although he has gotten better over time. Assuming he doesn’t appear overly hawkish or bearish (consistent is always best), whatever happens this afternoon shouldn’t have long range implications.
Today, model Ashley Graham is 32. Ivanka Trump is 38. Henry Winkler turns 74.
James M. Meyer, CFA 610-260-2220