Escalator Up, Elevator Down

We knew this was going to be a big week. It was perhaps the most significant week thus far in 2019 for investors. It was the busiest week for earnings, with nearly 1/3 of the S&P 500 companies reporting. That alone made it significant. In addition, the US trade delegation headed back to China in an attempt to revive discussions and salvage the possibility of a deal. It also brought the most widely anticipated Federal Reserve meeting of the year and another job report, a key indicator for the health of the US Economy. The Fed meeting was perhaps the most noteworthy of the many events. The week began with the DOW and S&P at all-time highs. It didn’t end that way. What was a calm move upward came to an abrupt end. It was the worst week on the year for stocks. The S&P fell 1% on Wednesday, snapping a 36-session streak in which the index didn’t move more than 1% in either direction. The S&P fell 3% from the highs. It also lost the 3K level. The DOW lost 27K.

Stocks were for sale this week, marking the worst 5-day session since March. The S&P 500 fell every day.  Global stocks were hit even harder. As expected, the Fed cut by ¼ point. The Market wanted more. So did the White House. But a strong job report for June raises the question of the need for that interest rate cut and complicates the prospects for another one.  Earlier in the week, the trade talks concluded with no action. It seems as though the US and China are further away from a deal now than was the case two months ago.  On Thursday, President Trump vowed to slap an additional 10% duty on the remaining $300 Billion of not-yet-tariffed Chinese imports on September 1, stoking the trade war. That sent stocks sharply lower and rocked financial markets around the globe. Bonds rallied, and yields fell, with the 10-Year Treasury yield closing sharply below 2%. Gold skyrocketed and continues to provide cover as a defensive position.  China doesn’t want a trade war, but it says it isn’t afraid of fighting one either. The Chinese foreign ministry said they would be forced to take countermeasures if the US is bent on putting more levies on Chinese goods.

The timing of Trump’s trade tweet is interesting and seemingly intentional. It came the day after the Fed cut interest rates and Chair Jerome Powell said trade tensions had returned to a “simmer.” The President has been highly critical of the Fed Chair for months. He expressed disappointment in Powell, calling for a more dovish stance at the Fed and the “beginning of a lengthy and aggressive rate-cutting cycle.” With a trade deal nowhere near, the President could be forcing the Fed’s hand or at least creating the crisis atmosphere and recessionary pressures where more rate cuts are needed. Trump might get his rate cuts by going after China. The Market is now pricing in two more rate cuts by year’s end and increasing bets of further policy easing in 2020.

We highlighted in May what we referred to as a Market metaphor with the check engine light turning on. That indicator was the inverted yield curve, which has predated every recession. That happens when shorter bond maturities yield more than longer-dated maturities, sending the credit markets out of whack. It’s important to note that even though every recession started with an inverted yield curve, not every yield curve inversion has led to a recession. But it’s still inverted, even though the Fed tried to steepen it with the rate cut on the front end. Interest rates around the globe keep falling. The 10-Year Treasury yield is back to the lowest levels since the 2016 Presidential election. The yield curve remains inverted in many areas. It is far worse overseas. In Germany, the yield curve is inverted in every measure, with negative rates in many. The French 10-Year Bond went negative for the first time ever. The Bond Market continues to tell a much different story than the Stock Market.

This has been the toughest Market environment I’ve seen in my 20+ year career. With growth slowing at home and more precipitously overseas amidst increasing trade wars and tireless tweets, it just didn’t make sense that the DOW and S&P were at all-time highs. Valuations in many stocks rival that of the Dotcom days. The Fed is playing a major role in propping up asset prices with its easing monetary policy. An interest rate cut with unemployment at 5-decade lows and the Stock Market at all-time highs is almost unheard of. We understand why they did it, but don’t necessarily agree it was needed. Not yet. We are Market people who believe natural cycles need to run their course. Central Bankers are acting like helicopter parents preventing their kids from experiencing life lessons and developing survival skills. Excesses are a natural byproduct of markets and commerce. They need to correct themselves. Premature intervention runs the risk of setting up a crisis. The Market is working through it.

The S&P went from a fresh, all-time high last week only to reverse lower and undercut the highs from last September. Despite the wide swings of volatility and new highs, there has basically been no progress for the Stock Market for a year.  Being an investor can be very humbling. We’ve been really defensive since April. We felt really smart in May with that correction. But it didn’t last long and new highs were reached in July. We felt frustrated and less smart in July. This week makes more sense to us.

The Stock Market tends to take an escalator up, but an elevator down.  Overbought lasts far longer than oversold. That’s just the way it is. This was an important week. We think this sell-off might have more to go before resolving itself. There are a lot of excesses that need to be addressed. There’s tremendous uncertainty that needs clarity. Brexit, Iran, trade wars and the global slowdown are at the top of the list. The US is in far better shape than the rest of the world. But we have our own election to resolve, which will bring plenty of debate and combat. And stocks are already pricing in a lot of good. Brace yourself for a whole lot more volatility ahead.

We’re all over it.

Have a nice weekend. We’ll be back, dark and early on Monday.


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