Saturday, June 8, 2019

This Week's Message: All We Can Be Certain Of, For the Time Being

Question: Which of the following two hypothetical headlines would make you feel better about the present state of the U.S. stock market?
1. Roaring economic prospects just sent the U.S. stock market to its best week of the year!
2. Waning economic prospects just sent the U.S. stock market to its best week of the year! 
Of course your answer would be #1. However, alas, the headline that explains last week's rally would be #2 -- as the presently waning economy (confirmed by last week's disappointing jobs reports) means that the Fed may be cutting interest rates sooner than later, and stocks typically love rate cuts.

My what a difference a month can make! 

Here's where fed funds futures placed odds of future rate cuts as of May 7th:

Here's the odds as of yesterday:

But here's the thing, while odds of future rate cuts were indeed trending higher already, those of a near-term cut exploded upwards when the President promised to hit U.S. importers with a 5% tax (tariff) on everything they bring in from Mexico. 

Here's the day before the President's surprise tweet:

Here's the day after:

Yes, my friends, it's the trade war that's troubling the economy!

Question now being, with Mexico tariffs off the table (per yesterday's 180), will the market (traders in the aggregate) be as certain of a Fed cut, come, say, July? And, frankly, was the market justified in its assumption to begin with?

With regard to the latter, Bespoke Investment Group says not-so-fast!  emphasis mine...
  • The market is now pricing a near-certainty (over 85%) change of a cut in July, despite the fact that only one member of the FOMC has argued cuts are necessary to support growth and push back against low inflation; that member, St. Louis Fed President James Bullard, has a history of getting carried away with market scares. 
  • Relative to what the market is pricing, recent FOMC communication has sounded relatively hawkish: the market is pricing multiple cuts this year, but FOMC is only gesturing at rate cuts as a vague possibility and numerous speakers continue to stress “patience” while talking up their assessment of economic activity. 
  • As a result, our Fedspeak Monitor Index has diverged radically from recent changes in interest rates, as shown in the chart below. 
  • In our view, it’s possible that the FOMC about-faces in short order, but the market is pricing much more radical declines in the policy rate with a very high degree of confidence. • It’s one thing to price an outcome as possible, and another to assume it as a done deal while also going much, much further. 
  • That difference—possibility from the FOMC and certainty from the market—is what’s driving the massive, unsustainable divergence between the tone of the central bank and the market pricing for what it does next.
So while absolutely the rally could continue right into Monday morning and trap more short-selling bears -- forcing them to cover (further exacerbating the up move) -- last week's upswing by itself, given what inspired it, hasn't inspired me to put new capital to work in any big way just yet.

Plus, the technicals, while improved, are a long way from signaling the all-clear:

Here's our daily S&P 500 chart (panels 2 and 3 denote bearish divergences [red lines] in those indicators):

And here's our weekly chart from back to the beginning of the present bull market:

Bottom line: For the time being, all we can be certain of is heightened volatility -- in both directions.

Have a nice weekend!

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