Nolte Notes 7.15.19

Nolte Notes 7.15.19

July 15, 2019

Plenty has come into focus over the past few weeks regarding the US economy. First, the jobs report reversed some of the weakness we saw in the May data. Combined with still steady wage growth, it was an indication that the US economy is not yet rolling over. Inflation data continues to come in weak, but the core rates were a bit higher than expected. While not yet enough to worry about, inflation remains below the Fed’s 2% target as it has for much of the recovery since 2009, so nothing new here. Manufacturing and service reports showed weakness as has the trade data. Finally, the global economy due in large part to the weakness in China is slowing and is showing signs of contraction. In a time long ago and seemingly far away, the Fed would be looking at those data points and likely hold steady. However, the Fed is also interested in keeping the financial markets happy (part of the unwritten third mandate!). The equity markets are demanding a quarter-point cut in rates at the end of the month with a still healthy possibility of a half-point. Europe stands to restart their bondbuying activities as well even with over $12 trillion dollars worth of bonds yielding less than zero. Central banks are once again forcing investors into the equity markets. Eventually, this charade will end, but when is still up in the air.

As the indices crossed over new high watermarks on Friday’s close, it also marked prices that have moved well above their long-term trends. Not yet parabolic, the persistent advance has investors flocking into the markets without regard of prices paid for stocks. Earnings season will be upon us starting this week with the banking sector in focus early in the week. It will be informative to see how companies characterize their earnings in light of the continued trade tariffs in place. For the banks, the inverted yield curve could garner some discussion as well. All that said, the markets look to move higher as momentum has taken hold and now it is more about the fear of missing out (FOMO) rather than fear of losing money. The risks are building, but the timing of any decline is a guess at best. As was said a month ago, the path of least resistance is to the upside, but returns over the coming few years are likely to be paltry from this starting point.

As Chair Powell did his best to indicate the Fed was going to cut rates without saying it so flatly in front of Congress, the markets certainly understood his meaning. What is interesting though is the reaction in the bond market. If rates are indeed cut, we’d expect bond prices to rise and yields to decline. However last week was exactly the opposite as bonds had their worst two weeks since April. Investors have bought up nearly everything that sports a yield above 2%, pushing valuations on utilities and other “safe” investments to near historically high levels. Commodity prices had their best six-week stretch since late 2017/early ’18. Inflation does not look to be returning with a vengeance. The better than 5% rise in commodity prices should be watched as an early signal that things are changing in the commodity world.

Just when we thought a diversified portfolio was the ticket this year, investors have moved back to the largest stocks within the markets. The second quarter saw over one-third of the returns in the SP500 come from the five largest stocks within the index. Large-cap tech has regained the performance lead from real estate and utilities. Going lower in the market cap world, the worse the performance and sending money overseas has also lagged the SP500. Once again, the SP500 reigns as the top asset class year to date. That is not to say the returns are terrible elsewhere. No one should sniff at a 10% gain after six months in the international markets, but compared to a 20% gain in the SP500, it pales by comparison. The same is true when looking at growth stocks vs. value stocks. We saw signs that value was finally(!) taking the performance mantle from growth at the end of 2018, but that has reversed at this point of 2019. Throwing caution to the wind seems to be the best way to invest these days. The markets seem to be bending the will of the Fed and maintaining historically low interest rates to keep the party going. The hangover will be a doozy whenever it hits.

The implication from the Fed cutting rates is that things are not well in the economy. Investors are certain a rate cut will solve the ills facing the economy. However, trade is something well outside of the Fed’s purview that cutting interest rates will solve. Keep an eye on trade discussions for the next direction in stocks.

The opinions expressed in the Investment Newsletter are those of the author and is based upon information that is believed to be accurate and reliable, but are opinions and do not constitute a guarantee of present or future financial market conditions.