All eyes on Fred, I mean Fed
As the market had made clear was going to happen the last several weeks, on Wednesday this week the Fed did indeed cut rates yet again, the third rate cut since July. The Fed has now not only taken back the two rate cuts they put on late last year (cuts that many felt went too far, or were too quick, in the cause of normalization) but has gone one cut past that, really making it impossible to refer to this as "insurance cuts." A few things worth pointing out about the Fed actions and statements this week ...
(1) Chairman Powell specifically said that if and when trade tensions are resolved, it will not necessarily mean these rate cuts will be reversed
(2) That the Fed is not merely trying to get to their 2% inflation target, but overshoot it (part of a new approach whereby the Fed believes a blended inflation target is appropriate, allowing them to run hot to offset periods of running cool)
(3) That this whole period may last a while (many had the impression they would be in a hurry to normalize after this)
Powell seemed to be very clear this week that he has capex on his mind (I assume you all know that so do we), and that he believes a resurgence in business investment will come from trade war resolution.
Why is business investment and its significant decline over the last year versus the year prior so directly correlated to the trade war? The timing of when the decline began is hard to ignore. The Fed feels that their excess monetary accommodation of late will not be the catalyst that re-ignites it. I think they are exactly right. A resolution around what caused its decline (i.e. trade war) will be what reverses it. I do not believe the cost of capital was ever an impediment to additional capital expenditures. Rather, the Fed intends for the lower rates to offset some of the impacts of that business weakening, not reverse the weakening itself.
A China Clue
Vice President Pence gave a speech last week that I believe has ramifications to how we view the trade developments with China. There were certainly some hard-line things said and intimated about the U.S. position against China but none that were "new news." The overall direction of the speech and its indications of strategic intentions were hard to miss. The use of the term "mutual respect" was new, and sounded like what China has been asking for. There was a reiteration, essentially, that the U.S. is not looking to change China into the type of society the U.S. is. He said it was "a resounding no" regarding the potential U.S. intention for decoupling from China. He talked about good faith, a new future, forging bonds, etc.
My conclusion had been and continues to be, that the phase one deal will close, and that both sides are now in deal-making mode ahead of the 2020 election. A "melt-up" of equity markets cannot be ruled out, even if it is a low probability event. A "standard fare hold-in-place truce" agreement does not produce a market melt-up, but some form of repeal of present tariffs put on in 2018 is not priced into the market and is possible - possible - as an outcome here.
What does this mean for you and your view of equity markets?
Look, there are plenty of risks, always, that loom around for equity investors. If one wants to put the November 2020 election results out there as something they are concerned about in allocating capital to stocks right now, fine. Global economic conditions are tenuous. The specifics of the China trade outcome are not completely clear. And I could strain for a couple other
excuses concerns as well.
But here are the facts of the matter that really ought to be the primary thinking from a low-hanging fruit, top-down, macroeconomic, asset allocation perspective:
(1) The Federal Reserve is not only not serving as an impediment to "risk-on" right now, but they are also full-blown, pedal-to-the-medal, accelerating with monetary accommodation, producing every reason risk investors could imagine to not hold back, justifying higher and higher valuations.
(2) The China trade war has moved in the right direction, maybe really, really moving in the right direction, and we know all political motivation in the world exists to make it go even further in the right direction.
(3) Bond yields and cash yields are at levels so low they lack precedent, and many international markets are fearful for investors.
If these three factors do not provide some hint, imperfect as they may be, that U.S. risk markets are likely to be, worst case, the "TINA" trade for some time to come ("there is no alternative"), and best case, a really attractive place to deploy capital, I cannot imagine what macro environment one would need to see.
Yeah, but earnings?
Yes, what about earnings? Through earlier this week, 55% of the S&P 500 had reported Q3 results. Thus far 74% have beaten earnings expectations, quite a bit more than the average of 67%. More impressively, 64% have beaten revenue forecasts. Earnings expectations are tracking 2% better than consensus forecasts were indicating coming into earning season. We have a ways to go, but the earnings results are outperforming thus far. The blended expectation is now a 3.3% decline year-over-year (better than the 4% expected decline of just weeks ago). We shall see how that nets out.
And did I mention?
There is still $500 billion overseas that U.S. public corporations are repatriating from foreign markets - half of a trillion dollars. The stimulative impact from repatriation has outperformed expectations so far, and there is more to go. This is after the ~$1 trillion that has already repatriated. The amount of repatriation, by the way, does help partially explain the dollar's stubborn persistence in staying well-bid, as forced buyers of dollars as money comes back in has been consistent. It is important to point out that about 60% of the repatriated cash went to capex, M&A, higher wages, and reducing debt (just 41% went to stock buybacks and dividends).
So what does the Fed do next?
The Fed has gotten its fed funds rate down to 175 basis points on the low end, but the futures market is now pricing in just a 20% chance of yet another rate cut in December. It should be viewed as a good thing if they do not cut yet again. It would require a "material change to their outlook" to cut again, and a material change would mean that they were now very concerned economically. At this point, investors should be very, very careful about what they wish for (no matter how much money you have borrowed).
That said, I firmly believe the stock market is their bellwether, so if stocks stay elevated, they let things sit for a bit, yet if markets plunge again, the "Powell put" comes back into play. I don't like it, but I call it like I see it.
Does it matter what the Fed has done or does next?
I am not sure that a precedent of two prior occurrences tells us much, but this historical context should at least be understood and known, even if its application is not totally clear.
But longer term?
$1 trillion deficits during a good economy? Dear Lord.
Socialism in Washington D.C.? You never know.
A world awash in negative-yielding debt, distorting markets, mal-investing capital, and suppressing healthy banks. No one should predict how this will end, because this is a science experiment no one has ever seen.
It is no time short term, intermediate, or long term, to get lazy. The profit motive still works. And yet intervening forces do their very best, it seems, to make that more complicated than it needs to be for the rest of us.
GDP Mixed Bag
The Q3 GDP growth number came this week, and there is something in it for everyone. The real growth number was +1.9%, quite a bit higher than the +1.3% number many were expecting and even better than the +1.6% economists predicted. And yet, in the weeds, the number is not all good. The out-performance came from continued consumer spending and government expenditures, with business investment going the other way, as equipment spending dropped 3.8%, and business investment contracted for the second quarter in a row after twelve consecutive positive quarters.
Politics & Money: Beltway Bulls and Bears
- People ask me a lot if the polls scare me, and the fact of the matter is that what scares me the most is how unreliable some polling methodologies continue to be. This is not the same as saying that they are "fake polls," or any poll which indicates "your person" is losing must be a lie. Rather, it means that we can't have one poll saying one candidate is up 15% (CNN, Biden/Warren) and another poll saying that candidate is down 7% (Quinnipiac, Warren/Biden), taken in the same week, allegedly measuring the same voters. Something is not right for two polls to be that far off from one another, so I do not believe it is fake, conspiratorial, or anything else - I just think it is methodologically flawed, and therefore unreliable. The best remedy any of us has found is to use polling averages that combine all the good, bad, and ugly together, to at least track trajectories.
- The word continues to be that NAFTA 2.0 is extremely close and that U.S. Trade Representative, Robert Lighthizer, and House Speaker, Nancy Pelosi, are at or at least extremely near a final deal. A House vote appears likely before the end of the year, and will represent a political victory for President Trump (keeping a campaign promise to re-negotiate old trade deals), a political victory for Nancy Pelosi ("we are walking and chewing gum at once - we did impeachment and passed NAFTA reform, all at once), and an economic victory for markets as a potential impediment to economic clarity and confidence is removed.
Chart of the Week
I will be downloading a lot more information next week about credit markets in our country and what my recent New York trip reinforced for me about leverage in the corporate sector of our economy. However, for whatever concerns exist about deteriorating credit conditions in various non-financial companies, the leverage in our financial sector has been dramatically reduced, certainly changing the systemic risk profile of our economy.
Quote of the Week
"The road to success comes in four stages. They are dreaming, thinking, planning and execution. Everyone can dream, fewer can think, fewer still can plan and the people that know how to execute are a very rare breed. Learn how to execute."
-- Mark Grant