Dovish Fed and Trade Deal With China Hopes Cause Stocks to Rally

Dovish Fed - Another Big Rally: The Market Wants Dovish Guidance

Hoping for a Dovish Fed, the market ramped higher on Tuesday. Many investors are not as pessimistic on the economy as we were before the solid industrial production & retail sales reports came out.

But, we're still nervous about where stocks will go in the next 2 weeks. It all comes down to 2 critical upcoming events. The first is the Fed meeting on Wednesday. I expect the Fed to guide for 1 cut this year, but I see a scenario where it doesn’t. If the Fed doesn’t guide for a cut this year, it is eliminating the potential for a July cut.

As you can see from the chart below, there is now a greater chance of a cut in July than in September.

Fed funds futures market has the odds of at least one cut by late July at 83.7%. Even if stocks were 5% lower, I think they would decline sharply if the Fed didn’t guide for a cut.

Market being within 1% of its record high ups the ante. Risk of at least a 2% decline on Wednesday is high if the Fed doesn’t tell the market it will cut rates this year.

Trade Deal Expectations Increase

Dovish Fed - The second event in the next 2 weeks is the G-20 summit which is from June 28^th to June 29^th.

As predicted would happen, there is a great deal of posturing ahead of this summit.

President Trump tweeted, “Had a very good telephone conversation with President Xi of China. We will be having an extended meeting next week at the G-20 in Japan. Our respective teams will begin talks prior to our meeting.”

It’s impossible for Presidents Trump and Xi to come up with a deal in 2 days of meetings without substantial discussions beforehand.

President Trump is really keying on this summit.

Dovish Fed - Trade negotiations have been going poorly in the past 6 weeks ever since China backed out of them.

Similar to the Fed’s meeting, I’m nervous about the market starting to price in a deal before there is one. There should be a stock market decline if the meetings don’t lead to anything.

If the Fed doesn’t guide for a cut this year and the G-20 summit ends up leading to more tariffs later this summer, the market can easily decline 10% from now until the announcement of the new Chinese tariffs.

Dovish Fed - Details Of Tuesday’s Action

On Tuesday, S&P 500 rallied 0.97%, Nasdaq increased 1.39%, and Russell 2000 was up 1.14%. S&P 500 is now down 0.95% from its record high.

Stock market did indeed need improved economic reports, Fed to guide for rate cuts, or trade negotiations to go well to reach its record high. There are certainly hopes for rate cuts later this year and a trade deal soon. But all we have now are modestly improved economic reports that suggest Q2 GDP growth will be around 2%.

Keep in mind that the record high isn’t the only technical barrier for the S&P 500. It peaked at slightly lower levels in January and September 2018.

Dovish Fed - There needs to be a significant rally to prevent technical analysts from labeling this as a triple top.

If there is a trade deal and economic reports bounce higher because of that in Q3, we could see the S&P 500 rally above 3,000. Even though the S&P 500 is within 1% of its record high, the CNN fear and greed index is at 44. Which is in the upper end of the fear category.

The index increased 7 points on Tuesday. It’s almost impossible that this stays at fear with the market at its record high.

Tuesday was a true ‘risk on’ day as the only 3 losing sectors were the utilities, real estate, and consumer staples which fell 0.31%, 0.34%, and 0.57%.

2 best sectors were technology and industrials which were up 1.72% and 1.89%. Those who claimed the utilities sector outperforming the market was a sign of a recession were wrong again.

It seems as though whenever that point is made, the sector declines. All is right in the world as the utilities sector is underperforming the S&P 500 year to date as it is up 16.11% and the S&P 500 is up 16.39%.

Merrill Lynch Fund Manager’s Survey

Dovish Fed - June Merrill Lynch fund manager’s survey has a bunch of data showing us that fund managers are very bearish. I will review the all the charts from this survey in the next few articles.

Let’s start with the most important one which is seen below. There is a record percentage of fund managers who see the global economy as being late cycle.

Specifically, 87% said that, none said the economy was early cycle, and about 13% said it was mid cycle. Technically, there have been 2 global recessions since the last American recession from 2007 to 2009. It was popular to call the economy mid cycle during those downturns.

The chart shows it was popular to call the economy late cycle in 2005, 2006, 2007, and 2008. Fund managers ended up being accurate, but they were a bit early.

Personally, I see the global economy having much more recession risk than the American economy. China has driven growth this entire cycle. With Chinese economic growth in a secular decline, it will be tougher to achieve above 3% GDP growth.

Besides the terrible Empire Fed index, there aren’t many data points suggesting the U.S. economy is near a recession. If there’s a trade deal, America can avoid a recession for at least a few more quarters.

Dovish Fed - Conclusion

The stock market is ready for a dovish Fed. Bulls better hope the Fed will guide for a cut.

Because if the Fed doesn’t, like Oxford Economics believes, the S&P 500 can fall 2%. Next catalyst will be the G-20 summit.

The hope is the negotiations leading up to the summit make the meetings successful. June FOMC meeting and the G-20 summit might determine how stocks do for the rest of the year.