After a dismal May, U.S. stocks have staged a nice rally. While until late April I was encouraged by the upward trend following the end of year lows, this current bounce is giving me some reason to pause.
In my opinion, in the fourth quarter of 2018 the investors sent a strong signal to the Federal Reserve, by sending stock indexes down nearly 20%, that they collectively felt interest rates had risen enough, and given the economic conditions at the time, a more “wait and see” approach was warranted before additional interest rate increases were merited.
After its December meeting, the Federal Reserve indicated that it would take a more data-dependent approach going forward. Investors appeared reassured and stocks rallied soon after.
This rally continued to climb a wall of worry into 2019, as investors traded stocks to new highs despite on-going issues such as failing Brexit negotiations, dramatically slowing growth in China and President Trump’s high-profile tariff negotiations and rhetoric.
In May, the increasingly loud tariff rhetoric and lack of progress in China negotiations seemed to spook markets once again, as bond yields dropped (a sign of fear) and stock prices followed.
Which brings us to this week. With stocks up nicely in June what has changed? Well, in my opinion nothing good.
With bond yields dropping, and trade negotiations dragging, a new murmur is growing in the financial press. Instead of simply being satisfied with interest rate stability, public expectations among investors have now transitioned into calling for the Federal Reserve to reduce interest rates at its next meeting.
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In this type of expectation environment bad news for the economy tends to become good news for markets.
On Monday of this week, the Bureau of Labor Statistics released May job growth numbers. While still positive, job growth did slow after very strong April numbers. According to Marketwatch, investors, as indicated by the futures markets, are now putting about a 70% probability of the Fed cutting rates in June.
I don’t like it. The Federal Reserve’s motivation to reduce interest rates would revolve around data indicating the growing probability of a U.S. recession. A stock market rally based on concerns about recession does not instill me with confidence.
To be clear, I do not think a recession is imminent. With interest rates in the low 2% range, a business-favorable tax environment, a much more balanced regulatory environment and a huge Millennial population moving into the consumption-heavy later stages of young adulthood (kids, houses, mini-vans etc.) I just don’t “feel” a recession.
If, however the stock market needs lower interest rates, driven by fears of recession, to resume its upward trend, then I will have to think long and hard about how to best manage investments in these circumstances.
In my opinion, a much more healthy upward trend would be driven by reduced tariff rhetoric and some sort of resolution to the U.S./China trade spat. So instead of just watching the direction of the next stock market trend, I think it will be prudent to base investment decision-making on the “why” behind the trend as well. If good news can become good news again, I will feel much more comfortable with markets going forward.