Sentiment in the stock market is swinging to the dark side as trade tensions are blamed for fowling up a “global synchronized recovery”. But is that type of stock market natural? Should all markets across the globe go up at the same time for years on end? Doesn’t that mean there is no diversity when everything correlates in the same direction? Who has the power to suppress price volatility? Who or what could cause such a state of affairs? Kilroy? The Sandman? Easter Bunny? Under Dog? Spanish Fly? It’s a mystery inside an enigma. Perhaps economist David Rosenberg from Gluskin Sheff can enlighten us from a tweet he sent out this week:
“If the Fed raises rates and shrinks the balance sheet as much as it says it will, the cumulative de facto tightening by the end of 2019 will have totaled 5.25%. If you don’t think this is enough to cause a recession, take note that the Fed tightened 4.25% bps from 2004 to 2006, by 350 basis points prior to the 2000 downturn, and by nearly 400 basis points in the lead up to the 1990 pullback.”
In other words, the Fed has a great deal of influence to create any type of economic environment that it wants – but only for so long. Why does the Fed do this? In times of stress, the Fed provides a crutch to capital markets until the economy heals itself when it is ready for the Fed to reverse policy and withdraw stimulus. As long as the Fed isn’t too aggressive, this approach can work. However, when the Fed gets too aggressive it creates a bubble that will be popped by the laws of economics and mean reversion. This is what happened in the real estate markets from 2002 to 2005 that eventually led to the financial crisis of 2008.
We are in unchartered waters when EVERY central bank on the planet has followed the Fed into a very aggressive central bank policy of ultra low interest rates and expanded balance sheets. These policies are beginning to reverse now with the Fed leading the way. Will stock markets hold up? How high does GDP have to be to buffer the reversal of the Fed’s policy? I don’t think its the 2-3% growth rate we are seeing now.
Prices never lie so let’s take a look at a few charts:
Junk bonds are succumbing to selling pressure.
Small capitalization stocks are pulling back..
Technology has been weak, especially the semiconductor sector…
The S&P 500 seems to have missed its chance to make a new high along with the Russell 2000 and NASDAQ these past several weeks…
I always leave the door open for alternate scenarios but this past week of price action makes me believe that the stock market will struggle in the coming months.
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Chart of the Week!
Economic & Central Banking Snippets
- US Real GDP grew at a slower pace than forecast (2%) in Q1, confirming a muted start to 2018. Will there be a deceleration that carries into Q2 amid rising trade tensions?
- Starting next week, the liquidity flow from both the US Federal Reserve and the European Central Bank (ECB) will go negative for the first time in years. This will be more pronounced in Q4 when the Fed’s balance sheet shrinks by $150B and the ECB will reduce the amount of bonds they will be buying. This all ties into rising volatility and weakness from emerging markets. (Boock Report)
- Japan’s unemployment rate fell to 2.2% last month, according to its statistics bureau, the lowest level since October 1992.
- Personal income rose 0.4% in May, a slight pick-up from a downwardly-revised 0.2% in April. Personal spending, meanwhile, was weaker than expected in May at +0.2% which was well below consensus of a +0.4% gain. The Q2 spending profile now shows a deceleration throughout the quarter: 0.6% in March, 0.5% in April and 0.2% in May. (MS)
- The May report on durable goods orders came in at a -0.3% following a strong 1.9% increase in April. The report showed continued softness in orders for transportation goods. (MS)
- A key measure of US inflation hit the Federal Reserve’s 2 per cent target for the first time in six years in May, bolstering the case for policymakers to stick to its pace of interest rate rises. The Fed’s preferred measure of inflation, the core personal consumption expenditures price index (PCE), climbed 0.2% last month, according to the latest data published by the Commerce Department, and was up 2% from a year ago, after hitting 1.8% in April. The Fed has made the 2% target for core PCE — which excludes the volatile food and energy components — a key factor when weighing interest-rate moves since the financial crisis. (FT)
- Harley-Davidson said it will shift production of EU-bound motorcycles away from its US-based manufacturing sites as a result of Brussels’ decision to retaliate against Washington’s tariffs on imported steel and aluminum. The famed maker of motorcycles said the financial impact of the EU tariffs would be up to $100m per year.
- Turkish voters gave President Recep Tayyip Erdogan a decisive victory in national elections on Sunday, lengthening his 15-year grip on power and granting him vastly expanded authority over the legislature and judiciary. Mr. Erdogan has overseen a crackdown on lawyers, judges, civil servants and journalists under a state of emergency declared after a failed coup two years ago. His critics had portrayed Sunday’s election as their last chance to prevent Turkey from becoming an authoritarian state. The victory has potentially grave consequences for cooperation within NATO, security in Iraq and Syria, and control of immigration flows into Europe.
- Women in Saudi Arabia took to the roads Sunday, ushering in the end of the world’s last ban on female drivers. It’s part of Crown Prince Mohammed bin Salman’s liberalization and overhaul of the kingdom’s oil-dependent economy. According to Bloomberg Economics, the move is expected to add as much as $90B to economic output by 2030.
- General Electric plans to spin off its health-care business and unload its ownership in oil-services company Baker Hughes, people familiar with the matter said, betting that the once-sprawling conglomerate can reverse a painful slump by further shrinking.
- The debt load for U.S. corporations has reached a record $6.3T, according to S&P Global, as Wall Street investors brace for a stricter rate environment even as cash hoarding reaches a peak. The good news is that U.S. companies have a record $2.1T in cash to service that debt, however most of that cash is in the hands of a few giant corporations. (Seeking Alpha)
- Amazon is building out its own last-mile delivery service, pushing further onto the turf of shipping partners UPS and FedEx. The new program, called Delivery Service Partners, will let entrepreneurs run their own local delivery networks of up to 40 delivery vans emblazoned with Prime logos. “This is all about scaling cost effectively,” said Dave Clark, SVP of Amazon Worldwide Operations. (Seeking Alpha)
- Deutsche Bank has failed the US Federal Reserve’s latest stress test and Goldman Sachs and Morgan Stanley have been ordered to strengthen their balance sheets by limiting dividends and share buybacks. The Fed’s regulators rejected Deutsche’s plans to make payments from its US subsidiary to the parent group in Frankfurt, citing concerns about its capital controls, among other “qualitative” weaknesses.
That is all for now until next week’s Market Update. If someone forwarded you a copy of this report, you can sign-up directly at www.kiscocap.com.
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Paul J. McCarthy, III
President – Kisco Capital