As I write this commentary, it appears that the S&P 500 is heading for one of the worst weeks of 2019. What happened? The markets had fully expected a goldilocks outcome for interest rates at last Wednesday’s Fed meeting. The Fed did cut interest rates by a quarter of a percent. However, during the press conference, Chairman Powell threw cold water on the increasingly popular idea that the Fed change in policy marked the beginning of a longer series of rate cuts. Instead he indicated that the cut was merely a “mid-cycle adjustment.” The markets immediately dropped. The very next day, the President announced via Twitter another round of tariffs on Chinese goods. The markets swung nearly 600 points on the Dow.
As the market struggles to come to grips with the disappointments, we are looking at data. The extremely strong recovery of the US stock market in the first half of 2019 has been appreciated but there are signs that breakdowns could be dangerous to the rally. First, capital spending by companies has been disappointing since the tax cuts. Second, global manufacturing has dropped to the lowest since 2012. Lastly, uncertainty over future interest rates is complicating the picture.
Capital investments (CAPEX) are complicated because often different definitions are given for them. Furthermore, many economists and strategists thought that with the tax cuts in 2017, there would be a surge in CAPEX. Simply put, it has been disappointing. Nearly all of the money that has returned from overseas accounts has been used for corporate buybacks. This is illustrated when we look at the quarterly CAPEX data. Trends have been dropping. Thankfully there are still capital investments happening, but they are slowing as a trend that began over a year ago in all four major CAPEX segments. Here is a chart that shows the trends by quarter.
Global Manufacturing PMI is a good indication of economic activity that tends to be a leading indicator. As corporate expectations drop, less of the goods are produced. Unemployment and spending tend to follow PMI data. PMI is now the lowest that it has been since 2012. This trend is putting pressure on the likeliness of continued improvement in corporate earnings. Earnings are direct result of goods and services sold. With less to sell, profits cannot be higher. This also tends to be a leading indicator and is a derivative of corporate spending dropping. Here is what the Global Manufacturing PMI data looks like.
Lastly, figuring out what the interest rate policy is going to be going forward is a challenge! Data following a first-rate cut can be tricky to interpret. Ned Davis Research complied a list of first rate-cuts and the change in 10-year treasury rates 4 weeks later. At first the data tends to lead us to believe that on average rates tend to fall afterwards. However, in the last 4 rate cuts, the rates have tended to rise afterwards! This could be attributed to the fact that the Fed is communicating ahead of time and indicating more clearly what it plans to do. Whether that remains true is something that we simply cannot tell. Here is what the data looks like from history.
What does all this rather difficult data tell us? It is a good reminder that we should be careful about making too big of bet in any direction. This market is one filled with geopolitical risk and extreme possibilities in both directions. In this market, it is often most prudent to have a good strategy that allows for flexibility and is not yet taking huge risks and bets. We do not know if this is a one-and-done rate cut environment, a mid-term adjustment cycle or a change of policy direction altogether. We also do not know how or what the Chinese response to the latest tariff announcement will be. It does seem more likely that it will not facilitate a quick end to this dispute. This might be a good time to remain patient, but it certainly is a good time to also examine strategy. Does your strategy satisfy you on what if can do in whatever trend emerges from this week’s actions? A review could go a long way to helping you make sure that you are in the best position you can be in!
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