It wasn’t the cut, it was the message

A tepid start to the week led to a washout for US equity markets last week. Price performance across all three major equity market indices was highlighted by the fact that both the Nasdaq and S&P 500 posted their worst week since December of 2018. The elevated volume that accompanied the sell-off effectively informed investors that institutional players were reducing exposure.

The current market outlook shifted last week from confirmed uptrend to uptrend under pressure

The fact is, last week’s sell-off provided confirmation that though equity markets have all traded to record highs in recent weeks, there are reasons to be concerned about their near-term prospects. As Investors Business Daily put it this weekend:

Take a look at the Nasdaq’s stock chart. Resistance emerged in late August at 8133. In late April, the Nasdaq confirmed that area of resistance and then sank. In July, it seemed like the resistance was history, but Thursday the Nasdaq closed under the 8133 mark.

Over the past 11 months, the Nasdaq has essentially made no progress other than surviving a bear market drop of more than 20% from August to Christmas, and an almost 11% pullback from early May to early June.

Granted, those corrections led to recoveries that were playable. The bulls, though, would like to see something more long lasting and less sensitive to news.

Though the street received that expected 25 bps cut on Wednesday of last week, it was the commentary provided by Fed Chair Powell that upset the apple cart. His reference to a “mid-cycle adjustment” very effectively gave the street and markets what they were clamoring for in a cut, but held the line on any messaging that could be interpreted as meaning that additional cuts were not an automatic or that a cycle-end was in the offing.

Last week’s sell-off was triggered, at least initially, by the Fed’s framework around what the street should expect moving forward. It wasn’t earnings season. In fact, Q2 results have thus far provided better-than-expected results in over 60% of the case. Guidance, though guarded, has remained largely constructive. Economic data has been spotty, but not cause for investors to dump stocks for five consecutive sessions in what appeared to be a rush for the exits. No, it was the Fed’s 25 bps cut rate and follow-up commentary that triggered the broad-based selling, as counter intuitive as that sounds. For months we have been hearing about the urgency of a rate cut as a way of heading off a slowing global economy, a protracted trade war with China, and concern over slowing manufacturing here in the US.

In Q2, the prospect of a 25 bps cut in rates was welcomed by the street only to be levered up to a 50 bps in a matter of two months. Ultimately, the street shifted from pricing in a 50 bps rate cut after June’s Employment report was released back to a 25 bps cut. Since then, the street had coalesced around a cut of 25 bps along with the expectation that the Fed would signal a posture of additional accommodation in coming quarters. And that is precisely where the street was left flat-footed.
Chair Powell and the FOMC clearly think the economy is not heading off a cliff in the near-term and that it’s in better shape than the street would have them believe. The balanced message from Chair Powell and the FOMC left the White House frustrated and traders frustrated. That said, the Fed’s action and commentary last week was in fact data-driven. Last week I wrote about the notion that if the Fed were to cut rates, for the first time since the financial crisis, based on the need to get ahead of pending potential challenges rather than on most recent economic data, it would be a significant departure from his predecessor, Chair Yellen’s, approach to monetary policy.

What the FOMC and Chair Powell actually did last week was balance the need to address recent uneven economic data while positioning monetary policy to have a posture to absorb the potential of headwinds in the form of a protracted trade war with China and a slowing global economy. Simultaneously, Fed Chair Powell made the case that our economy is not necessarily at cycle-end, that policy remains data-driven on balance and that the Fed would not be boxed into a corner by either the White House or the street.

Another factor that played a role in last week’s sell-off was the announcement by President Trump on Thursday that he intended to slap additional tariffs on Chinese imports. Of interest to me, as an investor and equity market strategist, was the tone of President Trump’s tweets announcing the additional tariffs. It was comprised of calling China out for not following through on the purchase of American agriculture products (acting in bad faith), failure to halt exports of the highly addictive drug fentanyl (acting in bad faith), and an additional tariff of 10% on $300 billion in Chinese imports (punitive results). He concluded with his hopes to “continue our positive dialogue,” effectively letting the Chinese know that he is willing and eager to negotiate a fair trade agreement, but that he intends to hold their feet to the fire.

Fear of a protracted trade war with China has been one of the principle drivers of volatility and negative price action all year. Last week was evidence that it is a theme that remains front and center – and a variable that will likely continue to play out in coming quarters.
This Week’s Economic data highlight:

The EIA Petroleum Status Report is released at 10:30 am EST. Though the EIA report is not always a weekly highlight, it has been in recent weeks and months due to concerns over slowing global growth (consumption), tensions in the Persian Gulf (supply interruptions), OPEC production policy (production restraints), and US production. An additional factor in cried pricing comes in the form of volatility.

Weekly Jobless Claims, due out Thursday morning, are expected to remain in-channel with recent readings. Last week’s claims were 215k, the 4-week moving average stands at 211.5K. New Claims were a scant 8k.

The most significant release of the week comes on Friday morning. The Producer Price Index – Final Demand for the month of July is out at 8:30 am. Given the centrality of inflation, or lack there of in regards monetary policy, this report will be closely scrutinized. June’s readings caused some concern in that inflation at the PPI-FD level have remained below target. The M/M change in last month’s report was 0.1% – below Econoday consensus of 0.2%. Y/Y the PPI-FD stands at 1.7%. Less food & energy, the PPI-FD reading in June was 2.3%.

Flickr photo: Pressure by Thomas Hawk
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