Hello all – we hope you had a nice July. It’s hard to believe we are already into August!
Stocks saw modest gains in July, extending what has so far been remarkable year. The S&P 500 is having its best year since 1997, the Dow its best year since 2013, and the Nasdaq since 2009.
Stocks saw modest gains in July, extending what has so far been remarkable year. The S&P 500 is having its best year since 1997, the Dow its best year since 2013, and the Nasdaq since 2009.
July was mostly uneventful, too, with most of the action coming late in the month as the Fed meeting approached. Volatility was low and stocks traded in a narrow range.
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The Fed was the main topic on most investors’ radar as they held their policy meeting this past Tuesday and Wednesday.
The market was pricing in a 100% chance for an interest rate cut of 0.25% (which makes it cheaper to borrow money). However, many investors were hoping for a bigger cut of 0.50%. Many prominent, vocal critics were pushing for a bigger cut, too.
The market was pricing in a 100% chance for an interest rate cut of 0.25% (which makes it cheaper to borrow money). However, many investors were hoping for a bigger cut of 0.50%. Many prominent, vocal critics were pushing for a bigger cut, too.
As expected, the Fed did announce a cut of 0.25%, which was the first time rates have been lowered in over a decade.
However, the market sold off sharply on the news. Remember, some investors were hoping for more of a cut and Chairman Powell’s comments didn’t seem to indicate more cuts were coming any time soon. This caused the negative reaction in the market.
We believe this expectation was entirely unrealistic. Our economy is solid and still shows growth, so the need for increased stimulus to help the economy is unnecessary. The fact that they even cut rates was a surprise.
Further, it’s unclear how making borrowing even easier will boost the economy. Other countries have low rates and continue to lower them further (many have negative rates), but growth never materializes. At what point do they conclude their remedy is not the cure?
The only reason we see a cut being justified is to placate the markets. We’ve used the chart below many times over the past few months, which has been a reliable recession indicator.
It compares the level of the yield on the 2-year bond to the rate the Fed has set as its target interest rate. As you can see in the chart below, every time the Fed’s rate was higher than the 2-year bond yield, a recession followed (recessions are the gray shaded areas on the chart). This began occurring a few months ago and continues still today. However, the Fed lowering rates (to where the red ‘X’ is) reduces the chances of a recession.
We believe this expectation was entirely unrealistic. Our economy is solid and still shows growth, so the need for increased stimulus to help the economy is unnecessary. The fact that they even cut rates was a surprise.
Further, it’s unclear how making borrowing even easier will boost the economy. Other countries have low rates and continue to lower them further (many have negative rates), but growth never materializes. At what point do they conclude their remedy is not the cure?
The only reason we see a cut being justified is to placate the markets. We’ve used the chart below many times over the past few months, which has been a reliable recession indicator.
It compares the level of the yield on the 2-year bond to the rate the Fed has set as its target interest rate. As you can see in the chart below, every time the Fed’s rate was higher than the 2-year bond yield, a recession followed (recessions are the gray shaded areas on the chart). This began occurring a few months ago and continues still today. However, the Fed lowering rates (to where the red ‘X’ is) reduces the chances of a recession.
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As for the economic data released this month, GDP for the second quarter came in at 2.1%, which was higher than expectations. In the chart below, we can see how these results have been mostly steady in recent years versus the wide fluctuations in the previous years. This shows a healthy, sustained growth in the economy.
Consumer spending data has also seen some of the strongest numbers in a long time. Below we can see one metric, consumer confidence, remaining near recent highs.
Business optimism has recently taken a hit amid the rising trade tensions, but overall, small business optimism is still trending higher.
The one concern we have is a slowdown in manufacturing. This is likely due mostly to the trade fight, but it is something to keep an eye on.
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Finally, corporate earnings were another big story this month. We are currently right in the middle of the period when companies release their results, so it may be a little early to get a complete picture.
That said, the results so far have been better than expected. Factset reports that analysts estimated earnings to decline 2.5% over the past year, but the results are pointing to a slight gain of 0.5%.
That said, the results so far have been better than expected. Factset reports that analysts estimated earnings to decline 2.5% over the past year, but the results are pointing to a slight gain of 0.5%.
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Where does the market go from here? Stocks still appear to be on the expensive side in the short term and the upside potential isn’t as great. However, we don’t see the red flags that would make us overly cautious although it’s worth noting that August is traditionally a tough month for stocks. The market often does what most investors think it won’t do.
This commentary is for informational purposes and is not investment advice, an indicator of future performance, a solicitation, an offer to buy or sell, or a recommendation for any security. It should not be used as a primary basis for making investment decisions. Consider your own financial circumstances and goals carefully before investing. Past performance cannot guarantee results.
