The slow boat to China catches a tailwind(s) The slow boat to China catches a tailwind(s) http://www.federatedinvestors.com/static/images/fed-logo-amp.png http://www.federatedinvestors.com/daf\images\insights\article\yacht-full-sails-small.jpg July 12 2019 July 1 2019

The slow boat to China catches a tailwind(s)

We're cautiously bullish on stocks this summer but see potential storm clouds.
Published July 1 2019
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With the market trading near all-time highs and now just 4% away from our formerly “crazy” 3,100 year-end forecast for the S&P 500, Federated’s PRISM® committee last week took some profits, lowering our long-standing equity overweight another 2 points to 3%. As noted in Phil Orlando’s memo on this topic, we remain bullish through this year and beyond but feel it is prudent to raise a little cash—while still staying net long stocks—in the event markets pause for (in)digestion over the summer. Let’s review quickly the present tailwinds behind the market’s latest upward move and look to possible summer thunderstorms ahead that could spawn a pullback.

  • President Xi under increasing pressure to settle trade issues We thought it was less than coincidental that on the very weekend that President Xi relented and agreed to come back to President Trump’s negotiating table, yet another riot occurred in normally peaceful Hong Kong, the financial center of China. This follows a bevy of quiet announcements of Chinese factories being moved to Vietnam, along with the weekly drumbeat of poor economic data coming out of Beijing. Add it all up, and President Xi’s “President for Life” idea is looking increasingly at risk. He needs a deal with Trump, and soon. So caving in Osaka this past weekend came as no surprise to us.
  • The 2020 election campaign has started (as Trump is very much aware) Even as the G-20 meeting was about to get underway, last week saw the start of the 2020 election primary debates within the vast Democratic Party field. We note that the president couldn’t help but shoot out a few tweets on this from the Far East. As his attention increasingly draws toward 2020, it only increases, we think, his desire to get a good deal with China done. I note “good” deal because the president will not settle for less, and knows that politically even the Democrats will come after him if he does settle. However, he has a very strong hand and knows how to play cards. Our guess is a solid, comprehensive deal is coming. It will just take some time to get there. And we count the start of the 2020 election cycle a positive incentive on the U.S. side to close an agreement.
  • The Fed has our back Although the U.S. economy is still cranking along, it remains in a bit of a soft patch, partly driven by trade uncertainty and the negative impact on confidence that this brings. More importantly for the Fed, the ongoing pressures on core inflation coming from the digitization of the U.S. economy and the recent pickup in productivity that’s offsetting wage gains have brought into serious question the last Fed rate hike in December. With the market clamoring for two to three cuts, we think it likely that the Fed uses the opportunity offered by the July meeting to reverse the unneeded December 2018 hike. From there, it probably pauses. In our view, this sets a positive rates backdrop for the market, although we suspect it could cause a little midsummer indigestion as investors have to raise their short-term interest-rate assumptions back toward 2.25% from the present 2.1%. On net, for now, we count the Fed as a tailwind.
  • Biden’s ship is sinking Back to the election, another market tailwind could be the beginning of the end for the Biden campaign, which probably will be marked by one of debate’s memorable lines, “It is time to pass the baton.” Counterintuitively, we see this shift away from the one potentially market-friendly Democrat in the race as market supportive. Indeed, absent Biden, almost no other potential Democratic nominee would seem to have a chance to win back the important electoral votes that were lost in the Midwest and Pennsylvania in 2016. Without them, President Trump’s re-election would seem increasingly likely, giving the market four more years to enjoy his earnings-enhancing economic and tax policies.
  • OPEC locked in for higher oil prices Another fair wind this weekend came out of the OPEC meeting in Austria. By extending output cuts as far as the eye can see, and having non-OPEC member Russia announce it, the Saudi-led cartel has increased market confidence that oil prices will continue their upward trend, perhaps even to our $90 Brent target for 2019. With oil now a net positive for the U.S. economy, particularly its manufacturing sector, this likely rally in oil prices would give stock investors another reason to cheer.
  • Possible summer thunderstorms Despite all this good news, we do see some possible summer showers ahead. Potential storm generators could include the coming second-quarter earnings season, which won’t be great; “sausage making” on the trade deal, which could get ugly before it ends well; Brexit progress, or lack thereof, as both sides of the negotiation seem unable to shift their opposing stance on a negotiated settlement before October’s “Hard Brexit” deadline; and the Fed’s July meeting, where we think the market’s hope for a 50 basis-point cut is probably too optimistic.

So, while the market is celebrating the just-in-time arrival of a fair wind in its sails across the Pacific, at Federated we have been shifting our stance from our “all-out bullish” call at the end of last year to what I would now call “cautiously bullish.” If the market continues to march higher toward our 3,100 target, wonderful. But if we do get some summer thunderstorms, we have cash ready to reload. Enjoy the 4th!

Tags Equity . Markets/Economy .
DISCLOSURES

Views are as of the date above and are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector.

Diversification and asset allocation do not assure a profit nor protect against loss.

PRISM® is a registered mark of FII Holdings, Inc., a subsidiary of Federated Investors, Inc.

S&P 500 Index: An unmanaged capitalization-weighted index of 500 stocks designated to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. Indexes are unmanaged and investments cannot be made in an index.

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