The Fed has marked a top with the end of quantitative easing – don’t expect it to end anytime soon. Economic data is good, unemployment is low and inflation is rising but not enough for the Fed to be alarmed. So what is the Fed doing under Chairman Powell? They are normalizing interest rates that were too low for too long. No matter how they normalize, something will go down in price and in this case that is the stock market as the Fed withdraws liquidity from the financial system.
The Fed’s policies have suppressed equity volatility over much of the last 10 years in order to create a wealth effect (and wealth disparity). Mission accomplished. Now, how much will they take back? The Fed is not afraid of stocks moving lower as the rubber hits the road for the Fed when there is credit contraction and a lack of lenders. Keeping the lending machines going is more important than pumping up stock prices. The Fed may not even care if we lose some growth as long as the bond and credit markets keep working.
My prediction, the Fed won’t stop until they sniff a credit event. But keep the big picture in mind as all markets are interconnected and raising interest rates causes larger interest rate differentials between the U.S., Japan and Europe. These differentials are affecting corporate America too as evidenced by Anheuser-Busch InBev’s 50% dividend cut this past week due to currencies losses on overseas operations. And let’s not forget Europe’s weak banking system or the emerging markets that could kick-off the next series of credit events across the globe. I could get into the Trillions of notional in derivative contracts that exist between financial institutions but that is a conversation for the next credit crisis.
Time to look at some charts. I am dialing out to the multi-year charts where each candlestick is one month’s worth of price action. Normally, the monthly moves don’t show much change but the last few weeks have changed things. The current correction (or bear market) is starting to show up quite clearly as you can see below:
The S&P 500 Index monthly chart has yet to reach an oversold condition:
The Russell 2000 had its worst month this cycle:
Here is the NASDAQ Index:
Things to watch next week:
- End of month on Wednesday. Normally, we get buying but fund managers may be forced to sell given the wreckage in October.
- Economic data throughout the week on housing, Durable goods, payrolls ISM may all look good and give the Fed more confidence to keep raising interest rates in December. Good news may be bad news for stocks now.
- A rebound of some type could happen but you would need to see semiconductors, housing, banks and large-cap technology pivot higher.
Chart of the Day!
It looks as though Amazon’s chart reflects this strength:
Economic & Central Banking Snippets
- The pace of US GDP remained solid during the third quarter despite losing some momentum as consumers shrugged off higher prices at the pump and lingering trade war uncertainties. Gross domestic product rose at an annualised rate of 3.5% in Q3 as the first of three readings from the commerce department.
- In a likely front running of the new tariff tax rate in two months on Chinese goods, South Korean exports for the first 20 days of October jumped by 26% y/o/y and imports were higher by 31.4%. I have no estimates to compare it to but those are large gains that can only be explained by the year end scramble for products. (Boock Report)
- Canada raised its interest rates on Wednesday for the third time this year to 1.75% in response to solid economic growth and after the country’s new trade deal with the US and Mexico eliminated one of the biggest risks the economy was facing. (FT)
- New UK manufacturing orders fell in the third quarter at their fastest pace in three years as fears over a disorderly Brexit quashed confidence in the sector. (FT)
- US Pending home sales rose .5% in September following a 1.9% decline in August. The chief economist of the NAR said a lift in inventory helped to bring buyers into the market. There was an acknowledgement though that “With rising mortgage rates and high prices, conversations about the possible benefits of renting over buying have begun to pop up.”
- Earnings as usual are beating forecasts by about 70%+ while the revenue beats have been about 55%, the lowest pace since last year. As for earnings, the two main factors that lifted profit margins in this cycle have been historically low interest expense and labor costs that were the lowest percentage of profits since WWII. (Boock Report)
- Netflix announced plans on Monday to issue $2bn in dollar and euro denominated junk bonds to help it finance its heavy spending on original movies and television shows. The company behind hit shows such as House of Cards and Orange is the New Black is planning to spend more than $8bn on original content this year, up from $6bn in 2017.
- The cost of protecting against companies defaulting on their debt rose to levels last seen in December 2016 on Wednesday, as credit markets lurched lower alongside a global rout for stocks. Markit’s investment grade and high yield CDX indices, which each track a basket of single name credit default swaps tied to the likelihood companies will renege on their debt payments, rose to 69.7 and 381.5 basis points, respectively.
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.
Please reach out to me if there is anything you want to discuss about the markets, your portfolio (for clients) or if you would like a copy of the firm’s brochure if you are not a client.
Paul J. McCarthy, III
President – Kisco Capital