Why Today's Market Looks a Lot Like the Late-2018 Correction
The two catalysts driving this bull market... The Fed's disappointing news... What to make of the trade war... Why today's market looks a lot like the late-2018 correction... How to navigate this choppy market...
The bull market is in danger...
And it's eerily reminiscent of the events leading up to last fall's sharp market correction.
Five months after bottoming on Christmas Eve, the market is up 20% – mostly thanks to two changing dynamics...
- The Federal Reserve's change of heart to stop raising interest rates, and
- What appeared to be improving trade negotiations between the U.S. and China.
However, earlier this month, those two catalysts came into question. In today's Digest, I (C. Scott Garliss) will explain what that means for investors... and how to navigate the current market environment.
On May 1, the Fed disappointed investors...
That day, many investors expected to hear Fed Chairman Jerome Powell announce plans to cut interest rates (or at least state that the Fed intended to do so in the near future). This would be seen as bullish for the stock market because it would signal a return toward "easy money" policy and increased liquidity – two of the driving forces behind this extended market rally.
At the time, the fed fund futures market – where traders can speculate on where rates are headed – priced in a 67% chance of a rate cut by December of this year and a 72% chance of a rate cut by January 2020. The mainstream media had also hyped the potential of a rate cut, fueling investors' expectations of such a move.
So when Powell maintained a neutral stance in the Fed's most recent policy announcement, investors panicked.
They assumed this was Powell doing more of what he had done before. Prior to his recent change in tone back in January, Powell had become known for his tendency to raise rates. And in the past, this type of commentary has weighed on the markets...
In fact, almost every time Powell has given a speech after a Fed policy announcement, the market has finished down on the day – six out of seven times. The Dow Jones Industrial Average has lost an average of 185 points on those days from the time he begins speaking into the close. It's clear Powell has developed a reputation for bad messaging...
However, markets continue to price in another rate cut...
Many market participants still believe it's possible the Fed hiked rates too far last year. In fact, the fed funds futures market now forecasts an even greater chance of a rate cut than before – 78% by December and about 85% by January 2020. Federal Reserve Bank of Chicago President Charles Evans even suggested a rate cut may be needed to get inflation headed higher.
The Fed typically raises rates when inflation is rising and lowers rates when inflation falls. The thinking is that a rate cut now could help spur a rise in inflation.
Worse still, the White House is calling for an interest rate cut of at least 1%. Not only is this extreme, but it's also counterproductive. Fed officials are trying to stay politically neutral, but caving in to the president's demands would call that into question.
Given what we know of Powell, the lack of a rate cut left investors disappointed yet again... dragging U.S. stocks lower once more.
The problem is, the Fed says the current rate environment is perfect...
In between policy meetings, many members of the Fed give economic-focused speeches at various conferences.
The markets look at these events as glimpses into the thinking of the Fed's policymakers. Investors try to decipher what's being said to predict future policy actions.
Sometimes they're right. Sometimes they're wrong. But often the Fed uses these events as opportunities to slip its future plans into the market's psyche.
Since the May 1 announcement – and ahead of the next big meeting on June 18 and 19 – there have been numerous Fed speaking events...
Unfortunately for folks rooting for a rate cut, the Fed isn't saying what they want to hear. The constant message from the speakers has been that Fed interest policy is right where it should be.
Raphael Bostic, president of the Federal Reserve Bank of Atlanta, said he still sees a case for one rate hike this year. And St. Louis Fed President James Bullard – the Fed member most inclined to ease – said a rate cut doesn't make sense right now.
The Fed continues to come across as "tone deaf."
Remember, last September, the U.S. placed a 10% tariff on $200 billion worth of Chinese imports. The markets became worried about the growth outlook.
Then, on October 3, Powell stated during an interview with NPR that interest rate policy was a long way from neutral (meaning that it neither hurts nor helps the economy). The implication was that interest rates needed to go much higher.
The Fed refused to listen to those growth worries until the markets began to implode.
The second headwind for the market has been the failing relationship between the U.S. and China...
In early May, Chinese state-run newspaper Global Times reported that trade talks had hit an impasse. Global Times is notoriously pro-China, so anything it says needs to be taken with a shaker of salt. Regardless, the story spooked investors.
A week later, U.S. Trade Representative Robert Lighthizer and Treasury Secretary Steven Mnuchin met with President Donald Trump after returning from talks in Beijing. They told Trump that China was pulling back on commitments it had previously made.
Remember, Trump had originally suspended an increase in tariffs ahead of the March 1 deadline because trade talks were advancing. He said that would be the case as long as the two parties were making progress.
Trump took to Twitter shortly thereafter to vent his frustrations with the Chinese...
He warned that tariffs on $200 billion worth of Chinese imports would rise to 25% from 10% on May 10 and that another $325 billion in goods would be subject to tariffs "shortly." U.S. stocks – as tracked by the benchmark S&P 500 Index – have fallen about 5% since then.
As regular Digest readers know, a complete breakdown in trade negotiations followed...
The U.S. accused China of reneging on talks, saying China tried to change the terms of the trade deal at the last minute. China accused the U.S. of having done the same in the past. In addition, the White House once more said it would impose 25% tariffs on the balance of all trade with China.
Today, things look a lot like they did in the fourth quarter of 2018, just before the market fell 20%...
At the time, the S&P 500 was trading around all-time highs (like it is now). That's when Powell said the Fed was far from done hiking rates... and the S&P 500 tumbled more than 15% over the next several months before bottoming in late December.
While the latest commentary has been different, it's all in the same vein. Back then, the markets wanted the Fed to pause its rate hikes. This time, they're hoping for a rate cut.
Trump's threats on tariffs also echo those of last fall. Back then, the president was threatening tariffs because China was unwilling to discuss trade. Now, he's making threats to get a deal finalized. But it's a similar principle.
The stakes are high. What happens on the trade front going forward will make or break the markets in the near term. Tariffs of 25% on all trade would hurt earnings estimates for the S&P 500 – and pull the market lower. Plus, expectations for global growth would tumble.
Even though the economy seems to be in a much better place than it was late last year, the stock market could fall as quickly as it did in the fourth quarter. As we saw back then, any market sell-off would lead to more selling as hedge funds rush for the exits, pulling the entire market lower. It's not an ideal setup for investors who are nervous about a pullback.
Still, it's not time to panic just yet...
This situation is certainly worth monitoring. Given how dynamic trade talks are, confidence in the economic outlook can turn quickly... And if companies and consumers begin to rein in their spending, it can create a dangerous situation for the U.S. economy.
There's no need to rush back into the "water" at the moment. Until the trade talks settle, the markets are going to be volatile.
Take this time to raise a bit of "dry powder." Research high-quality companies with strong balance sheets that can survive the coming bear market. When they go on sale, take advantage.
Speaking of the trade war...
My friend and colleague Dr. Steve Sjuggerud is hosting an urgent event this week. This Thursday, May 30, at 8 p.m. Eastern time, he'll share his latest thoughts on the situation and what it means for stocks in both the U.S. and China.
If you haven't already reserved your spot, you can do so right here.
New 52-week highs (as of 5/24/19): Axis Capital (AXS), Blackstone Mortgage Trust (BXMT), iShares iBoxx Investment Grade Corporate Bond Fund (LQD), and Vanguard Real Estate Fund (VNQ).
As always, we love to hear what's on your mind. Tell us at feedback@stansberryresearch.com. Remember, we can't offer individual investment advice. But we do read every note we receive.
Regards,
C. Scott Garliss
Baltimore, Maryland
May 28, 2019