50 Basis Points - Will the Fed Cut Rates Soon?

50 Basis Points - Another Rally: 2019 Has Been Fantastic

Will the Fed make the move to 50 Basis Points Rate Cuts soon? Large cap stocks rallied again on Thursday. S&P 500 was up 0.23% which puts its July gains at 1.98% and its year to date gains at 19.67%.

VIX fell 0.77% to 12.93. This rally in stocks pushed the CNN fear and greed index to 62 out of 100 which signals greed. Only category not in neutral, greed, or extreme greed is junk bond demand. It's in extreme fear.

As you can see from the chart below, 77.82% of S&P 500 stocks are above their 50 day moving average.

When this gets above 90, there will be extreme greed. It’s astounding that stocks have rallied so swiftly without achieving extreme greed. The correction in May did wonders for the market. Without that decline, the market would be ripe for a larger correction of about 10%.

Not all indexes rallied. Nasdaq fell 8 basis points and Russell 2000 fell 0.46%. This time the small banks weren’t to blame for the Russell 2000’s underperformance. KBW regional bank ETF was up 0.79%.  

Proposal To Eliminate Drug Rebates Withdrawn

50 Basis Points - Top news of the day which impacted stocks was President Trump’s withdrawal of his proposal to get rid of rebates from government drug plans.

White House stated, “Based on careful analysis and thorough consideration, the President has decided to withdraw the rebate rule.” The original goal was to eliminate these rebates. Due to the incentive for drug companies to set list prices artificially high.

This new rule was going to give pharmacy benefit managers a flat fee to put drugs on their plan.

50 Basis Points - And also let discounts be passed on to customers at the counter.

Because of this decision, Cigna stock was up 9%. UnitedHealth was up 6%, and CVS Health was up 5%. Merck fell 4.5%, Eli Lilly fell 4.11%, and Pfizer fell 2.45%.

Putting that all together, the healthcare sector ended up 2 basis points. The insurers’ gains and the drug companies’ losses canceled each other out.

Healthcare sector is closely watching the Democratic primary. Latest poll from NBC has Joe Biden up by 7 point over Elizabeth Warren. Joe Biden’s stock cratered after the debate in late June. But it has since stabilized.

In the average of polls, he is up 12 points on Bernie Sanders. Next change to the race over the next few months will be candidates dropping out. The primary started with over 20 candidates. Question will be who all that support goes to.

Real Estate Is A Big Loser As Rates Rise

50 Basis Points - Only 2 sectors that fell on Thursday were communication services and real estate. They were down 9 basis points and 1.21%. Real estate doesn’t like the rise in rates. 10 year yield is all the way up to 2.13%.

Obviously, that’s not a high level historically speaking. But that’s a big increase in the past few days as it was at 1.95% on July 3rd. 2 year yield is at 1.86%. That means the difference between the two yields is up to 27 basis points. Yield curve has steepened quite a bit recently.

As you can see from the chart below, the difference between the 3 month yield and the 30 year yield went positive for the first time since May.

If the curve steepens sharply after an inversion it signals a recession. But the bond market is a long way away from steepening enough to signal a recession.

Anytime the curve steepens you will hear recession calls. But those are overzealous just like all the recession calls in the past 10 years.

Best 2 sectors were the financials and industrials which increased 0.6% and 0.71%. It’s no surprise the financials were up. The yield curve steepened and rates increased.

50 Basis Points - 21.4% Chance Of 2 Cuts In 19 Days

As the sub-headline shows, there is a 21.4% chance the Fed cuts rates 50 basis points on July 31st. There isn’t much time for it to get to 70% which would convince me that it will happen.

If the stock market were to crater 5% in the next few weeks, that would make a cut more likely. But if a cut is priced in, it is bullish for stocks. That’s the catch 22. Just to be clear, there is no evidence that suggests the Fed can’t cut rates with the stock market near its record high.

The table below shows, since 1980 the Fed has cut rates 17 times with the S&P 500 within 2% of its record high.

A year later, the stock market was up every time with an average gain of 15% which is obviously fantastic. Worst performance was a 3.2% gain.

50 Basis Points - As you can see, there have been several 50 basis point cuts.

This time is different because rates are lower. It’s also different because monetary policy is much more reliant on forward guidance. Meaning, the current rate cuts are already priced in.

The stock market won’t react to the rate cut in July. Reaction will be based on forward guidance. Ultimate question is if stocks keep rallying with all this monetary stimulus, what happens when the punch bowl runs out of punch?

Fed’s hope is the next couple rate cuts spark a recovery in 2020, so we don’t have to find out.

Conclusion

50 Basis Points - It’s not surprising stocks have rallied this year. There was severe multiple contraction last year. Mostly because stocks fell and earnings growth was spectacular.

Question is how much more can stocks rally? That depends on how much 2020 earnings estimates fall. If 2020 EPS growth is about 5%, there is very limited upside in stocks in the intermediate term.

Stocks are hyped up on Fed rate cuts which is a dangerous sign. With this amazing rally this year, many indicators show there is some greed. But there isn’t euphoria. Q2 earnings season and the Fed’s guidance on July 31st are the next 2 catalysts for stocks. 

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