Not Fighting The Fed

The Fed has made its intentions clear and we can expect a reduction in interest rates at the end of this month. The Fed sentiment chart below illustrates how the Fed has flipped from its stance last October when higher interest rates (Hawkish) were going to be the new normal. The stock market put a full-stop on this policy.

The Market has largely been rangebound since the parabolic high in January of 2018 and is now breaking out to higher prices. The chart below shows the S&P 500 pushing above this range in what may be a new uptrend which may last several months.

SPX – S&P 500 Index

How long can the Fed keep up this game? Longer than you think or want. If we look at the price of the S&P 500 to tangible book value we can observe a record high multiple. Notice that we have surpassed the peak in 1998 – perhaps intellectual property like software is being overpriced? Perhaps. There are examples like cloud based computing companies which are all software and are beginning to generating positive free cash flow (which is tangible). But the chart below keeps things in perspective as bull markets like 1998 can way overshoot reality.

Earnings season will get going next week as nearly 60 companies in the S&P 500 are expected to report results including the big banks, Netflix, Microsoft, Schlumberger and Johnson & Johnson. Expectations for earnings are low as economists have ratcheted down GDP growth for Q2 so the bar has been set low which means the market will be forgiving with poor numbers. In essence, the Fed has put training wheels on the stock market so it will be hard for it to fall down – no helmet required.

Chart of the Week!

Economic & Central Banking Snippets 

  • Core machinery orders in Japan returned to contraction during May as the world’s third-biggest economy wrestles with the impact of global trade tensions. Core machinery orders shrank by 3.7% year on year representing the steepest fall in three months.
  • Spanish manufacturers reported tumbling orders and falling output as the eurozone economy continues to be hit by global trade angst and weakening growth. The closely watched IHS Markit purchasing managers’ index fell to 47.9 in June, down from 50.1 in May. The figure was lower than the 49.5 forecast in a Reuters poll. A reading below 50 indicates a majority of companies reported falling output. “Spain’s manufacturing sector entered into contraction territory during June, with the respective PMI reaching its lowest level in over six years” said Paul Smith, economics director at IHS Markit.
  • A separate IHS Markit survey covering Italy’s manufacturing sector was similarly gloomy. The PMI gauge fell to 48.4 in June, lower than the level in May and below expectations. It was the 11th month in a row in which the figure was below the 50 level. (FT)
  • Facebook’s Libra plans may mean central banks issuing their own digital currencies sooner than expected, the general manager of the Bank for International Settlements has told the FT. Agustín Carstens said: “Many central banks are working on it; we are working on it…and it might be that it is sooner than we think that there is a market”. (FT)
  • The impact of trade tensions on the global macro outlook is becoming more pronounced. Global PMIs continue to deteriorate while other corporate and consumer confidence surveys also indicate that sentiment has weakened. This will translate into further weakness in consumer and investment spending and global GDP growth.
  • Manufacturing orders in Germany dropped 8.6% over the last 12 months.
  • Australia’s central bank cut interest rates for a second successive month on Tuesday and the government moved to cut income taxes, as authorities unleashed a combination of fiscal and monetary stimulus to boost a slowing economy. This followed a similar 25bps reduction at its June meeting amid concerns of a slowdown in China, a domestic housing slump and weak consumption. 
  • The NY Fed model now pegs recession risk at 32.9%, a 12-year high.
  • Core consumer prices, which strip out volatile items like food and fuel prices, rose 2.1% (2% was expected). The report showed prices were up broadly with gains in apparel prices, used motor vehicles, rent and medical care services.

Macro Snippets

  • China is gearing up to channel billions of dollars’ worth of domestic savings to its tech companies through a new stock exchange modelled on the US’s Nasdaq. More than 100, ranging from artificial intelligence software developers to biotech and microchip makers, have applied to list on the Shanghai technology board, aiming to raise a combined $16bn. Beijing hopes the Star board, which is set to launch within weeks, will tempt fast-growing start-ups to choose it over the Nasdaq by offering them the chance to gain higher valuations. (FT)
  • Vietnam signed a landmark trade deal with the EU that will reduce tariffs on 99% of goods. The European Union has described the EU-Vietnam Free Trade Agreement (EVFTA) as “the most ambitious free trade deal ever concluded with a developing country.” Per Reuters, Vietnam has already signed about a dozen free trade pacts, including an 11-country deal that will slash tariffs across much of the Asia-Pacific, known as the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP). (Investopedia)
  • BASF SE slashed its profit forecasts, citing the continuing trade dispute between the U.S. and China as well as sluggish demand in the auto market, furthering the struggles at the German chemicals giant. The Ludwigshafen, Germany-based firm said that due to slower economic growth and trade conflicts, it now expects income and sales to decline for the full year, compared with earlier forecasts for growth in both segments. (WSJ)
  • Boeing is poised to lose its place as the world’s largest plane maker to Airbus after its deliveries fell by more than a third in the first half of 2019. (WSJ, FT)

That is all for now until next week’s Market Update – thanks for reading!


Paul J. McCarthy, III

President – Kisco Capital

Paul McCarthy

Mr. McCarthy is the President and founder of Kisco Capital.