August is just around the corner. While this is a notoriously slow month for stocks as many institutional investors go on vacation, the market is looking for direction. There are two questions concerning investors. First, is the market at a top or is it simply taking a pause. Second, how can you position your portfolio before the market goes on its summer vacation?
With good news like this, who needs bad news?
The market reached yet another record high in late June. But while the President, and others, were tweeting about and trumpeting the strong economy, many investors were selling equities. In fact, the market went lower after a July jobs report that was by any indication a sign that the U.S. economy is still showing strength. And although the market did come back off its low, there were indications that the market could have gone even lower if it wasn’t for low volume. Here’s what the Wall Street Journal had to say about Friday’s events:
“Markets, however, slipped Friday morning because investors viewed the solid jobs report as making it less likely the Fed will cut its benchmark interest rate by a half-percentage point, though a quarter percentage point remains a possibility”.
The market wants a rate cut … badly
Market bulls are working hard to make the case that the Fed needs to be proactive now to add fuel to a rally that seems like it’s getting tired. But Federal Reserve Vice Chairman Richard Clarida has said in June “the central bank can’t be handcuffed by the markets”. Clarida cited a rate cut as akin to the markets wanting to “have their cake and eat it too”. Still, after already dashing the market’s expectations for a rate cut in June, the Federal Reserve sounds like it may not want to “disappoint the market” again. This would mean they would likely institute a quarter-point rate cut when it holds its monthly meeting in late July.
The market is waiting on the Fed, but why?
After the Federal Reserve made the decision to hold interest rates steady in June, the market has been pricing in a rate cut for July. In fact, though there are signs to the contrary, most notably the latest job report, many analysts, including Morgan Stanley, are still predicting that the Fed will cut interest rates in July. Is this just wishful thinking? Or does the market need what is being called “insurance” in case the small cracks that some are seeing in the U.S. economy become more pronounced?
And what are those cracks? Market analysts will be quick to tick off a laundry list that includes:
- Rising bond market yields – Overseas investors are buying U.S. government bonds. This is causing bond yields to rise at the same time that equities are climbing.
- A closer look at the market by sector is showing that the stocks that are growing are in defensive sectors, suggesting a flight to safety is underway.
- Key manufacturing indexes are dropping near 50 percent. Anything below 50 percent signifies contraction in factory activity.
- The trade war with China continues, and even though it appears the two sides continue to talk, the lack of specifics is causing investors to question both the timing and magnitude of a potential deal.
- After peaking in 2018, corporate profits have been in a steady decline.
But, forgive my cynicism, there’s a simpler explanation to all this. The markets are addicted to stimulus. Whether it’s quantitative easing (which the President recently said would be a good thing) or a cut in interest rates “just in case”, the markets have come to expect the lift (the high if you will) that stimulus provides to most financial markets. And, as we get ready to enter an election year, there is no question that the Executive branch wants to use any parlor trick at its disposal to ensure that the economy does not teeter into recession.
So is the stock market at a top, or just taking a pause?
The simple reality is this. If the Federal Reserve cuts rate in July, the market will go up. If they don’t, the market will go down. And even if the Fed does not cut rates in July, they have already signaled that they will cut rates at the first sign of a market slowdown. Either way, a rate cut at some point this year is a near certainty. That’s the nature of politics and the market.
As an investor, this means you have to take both a short-term and long-term view. Ultimately, the market will have to be weaned away from the stimulus. But until that happens, there is money to be made in equities, and there are a lot of stocks, including blue-chip stocks like Delta Airlines, which are selling at a P/E ratio below 10. That speaks to the idea that there is still a lot of value in the market.