Author: Brett Ewing - First Franklin Investments | Date: 20 June 2019
The Fed gave the market what they wanted and pointed to multiple rate cuts heading into 2020. The other big issue facing us, trade, is starting to take center stage with a meeting between President Trump and Xi at the upcoming G-20 meeting in Japan.
The Fed can no longer stand the pressure the yield curve is putting on them and it looks like they are finally ready to admit they overshot their target.
The Federal Reserve: Rate cuts are upon us
The Fed is finally ready to right the wrong they committed with the December rate hike. . They can no longer stand the pressure the yield curve is putting on them and they are finally ready to admit they overshot their target. They have given the economy and inflation more than enough time to pick back up, but it’s more than obvious that at least one if not both of those metrics are going to remain slow. The trade war has made it tougher for the Fed to handicap the economy and we believe they tried to bet on an agreement in the last couple of decisions, but by now they can’t wait any longer to act. While they didn’t cut in this meeting, the signaling of multiple rate cuts is exactly what the market wanted to hear. We look for a rate cut in July and then for the Fed to step back for a few months and monitor trade issue resolution. They are keen on keeping the expansion going and have now shown they are willing to be flexible.
Trade Wars Forward Progress: Trade deal back on the table, market still skeptical
Breakdowns in trade talks between the US and China led to a market selloff in May, but it could be a blessing in disguise. Before the disagreement, markets were getting a little too giddy and we began to fear that even an agreement would lead to a sell the news type event. Now there is almost no one that thinks a deal could be done anytime soon and we are back to an environment that is at least in line with reality and at best overly pessimistic. Behind that backdrop, the risk-reward is more enticing to us here than it has been in a while as several individual names sold off more than we believe warranted. Making a deal in the face of the pessimism would also line up much more with President Trump’s public relations M.O. than the much-telegraphed deal we seemed to be headed for before the breakdown. We will be closely monitoring President Xi’s meeting in North Korea for any hints of olive branches to President Trump ahead of the G-20, as denuclearization is a big goal of the Trump administration and could be a useful card to play in any negotiation.
U.S. Economic Outlook: Continue to believe in acceleration in back half of year, led by housing, setting up for likely market breakout
We have said for the better part of a year that the main issues facing this economy were trade wars and rising interest rates into an unwilling consumer, and we believe that these are well-known and being dealt with. The first part of dealing with consumers falling back from big ticket purchases like houses and cars has occurred throughout the beginning of the year as rates have fallen across the board with a 30yr mortgage now below four percent. With the Fed beginning to cut, short term interest rates will follow suit and loan activity should pick up. We also continue to believe that the last issue, trade, will be taken care of before any material weakness is allowed to occur in the stock market. Because of a pickup in consumer demand and uncertainty with trade eventually being lifted, we believe a breakout to new all-time highs is likely to occur in the S&P.
While the Fed didn’t actually cut, we believe they threaded the needle on market expectations. Signaling multiple cuts into 2020 is just what the market needed to see to prove the Fed is willing to admit their mistakes and be flexible with an economy that has slowed down. We continue to believe that a trade deal will get done before any significant weakness in equity markets shows up. This along with a pickup in consumer demand in the back half of the year should lead to a breakout for stocks above prior highs made in September and May.
The Fed is sending the right message to the markets in 2019 vs 2018 and the U.S. job market will allow consumers to feel more confident overall, translating into continued progress in consumer behavior leading to a stronger housing market and improved retail sales for the remainder of 2019. A change in the business community psychology could evolve slower than consumer behavior.
With fund managers overwhelmingly positioned in cash, consumer staples, and utilities, a chasing phenomenon could occur as repositioning occurs and managers move money into more cyclical sectors of the markets. This should push the S&P above our 3,150 price target into the end of the year.
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