Market Strategy 6/24/2019

• Stocks rallied to new record highs last week on the back of Chairman Powell’s dovish comments after last week’s FOMC meeting.
• We make the case that a resolution to the trade war sooner than expected could reverse the need for a Fed rate cut.
• Stocks continue to appear more attractive than Treasuries, which we view as overbought.
• We update our market drawdowns table as the market hits new highs, just 17 days after a recent bottom.

The Federal Reserve Board threw the market a bone coming out of its FOMC meeting last week and the market snapped it up. Notwithstanding a little give back action on a quadruple witching hour Friday the S&P 500 closed at a new record high last Thursday of 2,954.18. Including the 0.13% give back on Friday the benchmark stands at the start of the new week just 0.2% away from our 2019 price target (which we initiated last December). We’ll hold our discipline and keep the party hats boxed for now recalling how on September 20, 2018 we saw the S&P 500 bearing down on our target of 3,000 for that year only to slip away.

Keeping that in mind we are of the view that stocks remain attractive at current levels and expect that barring unforeseen negative surprises they are likely to remain more attractive than bonds for now.

Our take on the Federal Reserve’s policy for some time has been that it is highly sensitive to both strengths and vulnerabilities within the US economy. The contemporary Fed in our view has over the course of the past nearly 12 years shown that it can manage monetary policy remarkably well considering that “everything but the kitchen sink” has been thrown at the US and world economy over that span of time.
We judge the performance of the Fed under the leadership of Chairs Bernanke, Yellen, and Jerome Powell (to date) remarkable compared to that of Fed leadership in earlier times when the gas pedals and the brake of monetary policy were subject to heavy foot pressure.

We don’t blame the Fed for the low interest rates stateside savers find on bank deposits and on many fixed income securities. While it and other central banks around the world from the Paul Volcker era forward have become vigilant against high levels of inflation it has not been in our view solely the efforts of central bankers that are to be credited (or blamed). Rather, we believe some credit should also go to the process of globalization and technological innovation that has led to a world in which inflation (even desirable reflation) is if not hard to achieve, then difficult to sustain long enough for interest rates since the Financial Crisis to rise and stick at levels much higher than a range of around 2% to 2.9%.

In the past decade the Federal Reserve Board has added deflationary concerns to its watch list as a result of those aforementioned trends and of late has begun to add
trade/tariff issues to its menu of considered risks.

We applaud the Federal Reserve’s sensitivity to the challenges the economy stateside could face should the trade/tariff war between the US and China be ramped higher. From there, we fear it could morph into a protracted affair overhanging the domestic and global economies, discouraging the consumer, and impacting businesses worldwide.
We persist in believing that a resolution to the trade dispute is if not around the corner at the G-20 meeting in Osaka (at the end of this month) at least somewhere in the not too distant future (perhaps over the summer months).

Should a resolution take place we would expect stocks to rally further higher from these new record levels and for bond prices to fall from their lofty levels (sending yields higher) pretty quickly as economic and corporate growth expectations stateside and around the world would likely be ramped higher. If such a scenario would unfold the Federal Reserve might not be cutting rates later this year but rather could be raising them once again by year end. Such a pivot would serve to remind any purveyors of irrational exuberance and animal spirits that the Fed remains committed over the long term to interest rate normalization—whenever the economy looks like it can weather the process.

Thinking back on the market mayhem of the fourth quarter of 2018 when the 10-year Treasury yield rose to a high of 3.24% in November and stocks tumbled nearly 20% from September 20th to December 24th we can’t help but remember the expectations in some corners of the market for the Fed to push rates high enough to cause a recession, the price of oil to keep falling on lack of demand (rather than on an increase in supply) and the thought that the trade war would likely find no resolution over the long term.

Two out of three of those expectations from Q4 2018 have since been taken off the table. Now those calling for a recession cite the risk of a protracted trade war and high levels of government and corporate debt among a host of other reasons as factors that in their view will end the current economic cycle and the market’s decade long bull run.

The fashionable call in Q4 around the equity markets seemed to be “don’t buy the dip”. To that we say so much for the value of negative projection and bearish views, with the S&P 500 currently up over 25% from December 24th through last Friday.

Given the market’s powerful rally since the bottom in Q4, the risk of a trade war resolution being further out than one might expect, and the value of a Fed “put” likely priced in we’d suggest a cautiously optimistic view towards the market. Such a right-sized outlook could prove more rewarding than getting too excited about the Fed’s perceived “put” and its implications for short-term market gains.

When it comes to investing, our mantra remains “know what you own, why you own it and have realistic expectations of how it should perform in changing market environments.” In addition, we’d also remind ourselves that diversification and patience are likely to be rewarded over the long run.