I'm going to need more popcorn
Did you watch the debates? It was striking how the Democrats broadly embraced a bold progressive agenda, even moderates. That came through loud and clear and, Cornerstone Macro believes, poses profound risks to financial markets. Of course, that would be the case only if President Trump loses. While some polls have showed him lagging the front-runners, election season is just getting started. The market historically has been a better of predictor of outcomes than the pundits and polls. In 20 of the past 23 presidential elections, if the S&P 500 had positive returns three months prior to voting, the incumbent party won, Strategas Research shares. Near term, we’re watching what happens in Osaka regarding trade. A Bank of America proprietary analysis indicates that trade-related news was enough to meaningfully move the market on 71 of the last 334 days, dragging the forward price-to-earnings ratio down by 1.2 points. It says a full reversal of this multiple compression could translate into 3,100 on the S&P, an outcome that, outside of other market-moving factors, could occur if hopes improve for a "real deal" that removes trade tensions.
It is also striking how the Fed over a relatively short period has changed its view of the neutral funds rate from above 4% to 2.5%. A lot of it has to do with inflation expectations, now near December 2018’s lows when the stock market was plunging on fears of recession. The economic data of late arguably supports the more dovish view, too. Almost every U.S. leading economic indicator declined and/or missed expectations this month, and corresponding global data weakened further. Market odds of a July rate cut are now 100%, continuing this year’s near-perfect inverse correlation between the economic data and the S&P—the worse the data has become, it seems the higher the market has gone as it anticipates easing. With more central banks adopting “insurance” cuts, the amount of negative-yielding debt worldwide has climbed to $13 trillion (perhaps explaining the moves in gold and Bitcoin!!). Medley Global Advisors cautions this growing mountain of negative yields could result in damaging capital losses once economies start to regain their footing, creating a catalyst for recession. But that appears to be a concern for another day. While it may seem rates are sending a bearish message, Cornerstone notes credit remains relatively sanguine, margins are signaling that profitability is good and leverage is under control. Recessions are periods of corporate restructuring, i.e., shedding excesses after too much investment, borrowing and hiring. That need just isn’t present today. Additional rate cuts would only add to liquidity already flooding the market. The growth rate for M2—a broad measure of money supply—has nearly quadrupled since the end of 2018 (perhaps explaining the moves in gold and Bitcoin!!).
UBS cautions “bad news is good news” never lasts forever. It recalls the Fed “puts’’ of 2001 and 2007, i.e., rate cuts during expansions, that helped lift stocks until S&P earnings growth flatlined. The evidence suggests this isn’t an imminent worry. Yardeni Research says analysts’ weekly forward revenues and forward earnings estimates rose to record highs late this month. Contrarian sentiment remains supportive, with equity ETFs continuing to see outflows and cash experiencing extreme inflows despite this month’s new S&P highs. While it may seem counterintuitive, elevated uncertainty (currently due to trade, tariffs, China, Iran, etc.) also is historically consistent with above-average forward returns, Strategas says. Under the surface, 20-day highs are expanding again—an important characteristic of durable advances. While a short-term pullback off June’s rebound is possible, the longer-term technical backdrop is bullish. Monthly momentum indicators continue to build positively from late 2018’s oversold levels, and the overall price structure of the S&P appears to be consolidating above its long-term secular uptrend, similar to what developed in 2011 and 2016, FundStrat says. Applied Global Macro Research reports that the U.S. market is only a bit on the expensive side of history when measured by a combination of four valuation factors—the S&P price/operating earnings-per-share ratio, dividend yield, buyback yield and inflation, nothing like it was in the late 1990s. This 4-in-1 factor does suggest modest returns but not an end to the up-cycle as long as the consumer stays strong and GDP growth holds at around 2%. Meanwhile, I love election season. And caramel corn, m’m, m’m, m’m.
- Housing is OK While the pace of new home sales fell in May to a 5-month low, it appears much of the shortfall resulted from seasonal adjustment problems with the data, since mortgage applications are soaring, residential bank lending is rising, existing home sales were good, permits and starts were decent and pending sales rebounded.
- Durable goods better than the headline Orders fell in May for the third time in four months but all of the decline was concentrated in transportation, which has been stung by the grounding of the Boeing 737 MAX jet. Ex-transportation, orders rose and, outside of defense and aircraft, durable goods were better than expected, with machinery and tech orders both up solidly.
- The consumer’s in a good mood Personal consumption expenditures were revised down in the final read on Q1 GDP, which held at a 3.1% annualized rate, as spending on services rose at its slowest pace in almost six years. A lot of this slowing has been attributed to a late Easter as more recent data suggest consumers are spending more. Bloomberg’s gauge of consumer comfort hit a 19.5-year high in its latest weekly reading and the final read on June consumer sentiment unexpectedly rose.
- Manufacturing slump continues at home … The closely watched Chicago PMI survey posted its first sub-50 reading in 2.5 years, putting the gauge of manufacturing activity in the region in contraction territory. Elsewhere, the Kansas City Fed said manufacturing activity in its region stalled, while the Richmond Fed said manufacturing there slowed to its slowest pace since January.
- … and abroad Eurozone manufacturers were their most downbeat in almost six years as hopes for a speedy resolution to a series of disputes between the U.S. and its main trading partners faded, a European Commission survey found. The drop in industrial sentiment pushed it below its long-term average for the first time since 2013.
- But I thought the consumer was in a good mood? June Conference Board consumer confidence sank by the most in almost eight years to its lowest level since September 2017. For the lowest-earning households, confidence was its weakest in three years, while vehicle purchase plans dropped a record 3.8 points to their lowest level in nearly a year and plans to buy major appliances fell to their lowest level since January 2015.
Can we get back to 3% growth? Historically, real GDP growth above 3% showed positive stock-dollar correlation and growth below 3% often led to negative correlation. This has meant a strong dollar has been more a foe than friend for equities the last 10 years, Leuthold Group says, with the market experiencing negative daily returns more frequently when the dollar rose compared to when the dollar declined.
Perhaps this explains the move in gold The Institutional Strategist thinks the nearly 8-year bear market in gold is over. It notes that new Basel III international banking regulations aimed at reducing systematic risk shifts gold toward officially being money again. It’s now considered a Tier 1 asset that can be used to bolster bank capital. So after decades of discouraging gold as an alternative form of money, central banks have a regulatory reason to encourage gold returning to its historical role and indeed, have been buying it themselves.
Automation may not be the threat some think An Organization for Economic Cooperation and Development study found only 10% of U.S. jobs are at risk of disappearing over the next 15 to 20 years because of automation, and that automation as a whole creates more jobs than it destroys. In fact, despite decades of increasing automation, U.S. jobs are at record highs while unemployment is at a 50-year low.