Powell - Another Down Day For Stocks
The 12 day losing streak in oil ended. But stocks continued to fall even though they are oversold. Personally, I’m done trying to go bullish in the short term. Fundamentals of earnings and the economy have eroded.
S&P 500 fell 0.75%, Nasdaq fell 0.9%, and Russell 2000 decreased 0.9%. VIX increased 6.14% to 21.25.
CNN Fear and Greed index fell from 10 to 7 which indicates extreme fear. It only briefly exited the extreme fear category earlier this month.
The S&P 500 is down 3.99% in the last 5 days and is only up 1.05% year to date. If stocks fail to rally in the next few trading days, the initial extreme fear readings in October will have been wrong in a 1 month time horizon.
CNN reading has historically had a good track record in predicting 1 month returns.
S&P 500 has quickly fallen back to the level where there is extreme multiple compression on the year. Stocks have barely rallied while earnings have grown over 20%.
So far, this decline looks a lot like the one in the winter of this year. Stocks recovered in February before moving lower in March.
If stocks bottom where they did a couple weeks ago, it will mirror it. The key difference is the Fed has raised rates 3 times since then. It also plans on more hikes in the coming quarters.
Powell - Fed Chair Says The Economy Is “In A Good Place”
Fed chair Powell is excited about the economy which. That's bad news for stock investors. It means more hikes are coming which will slow the economy.
He stated on Wednesday, “I’m very happy about the state of the economy now. Our policy is part of the reason why our economy is in such a good place right now.”
Actually, the fiscal stimulus is a big reason why the economy had a strong 2018. The Fed’s rate hikes will start to slow growth in 2019.
It’s scary to see the Fed very happy with the economy while the ECRI leading index is at a 139 week low. This is the definition of hiking into a slowdown.
Stocks had a great 2017 as they forecasted 2018’s economy would be strong. Now stocks are having a below average year despite high earnings growth because they see challenges in 2019.
Powell - Global Economic Growth Weakens Further
On the weakening global economy, Powell stated this is “not a terrible slowdown” as the global economy is “gradually chipping away” at the pace of growth.
That’s disconcerting because he really doesn’t know if this will be a terrible slowdown. All we know now is the Chinese and European economies are weakening. They have been weakening for a few months.
There isn’t evidence that this will reverse course soon. If it doesn’t, this could become a terrible slowdown which morphs into a recession. A recession is far from a lock. But this slowdown ending in 2019 is also not guaranteed.
As you can see from the table below, German GDP growth contracted 0.2% in Q3 which missed estimates for -0.1%. That’s the first negative GDP print since Q1 2015. On an annualized basis, growth was -0.8%.
In October, China’s year over year retail sales growth was 8.6% which is a 5 month low. That missed estimates for 9.1%. That’s down 0.7% from the growth rate in September. Year to date sales growth fell 0.1% to 9.2% and online sales growth fell 1% to 26.7%.
The pre-buying of Chinese goods due to the coming tariffs at the start of 2019 helped push up fixed asset investment growth and industrial production growth. But those are likely temporary blips higher.
Specifically, fixed asset investment grew 5.7% year to date which beat estimates for 5.5% growth. Industrial production growth was 5.9% year over year.
Powell - All Meetings Are Live
Powell stated, “Certainly all meetings are live now, there’s no question about it now. Over time, folks will get used to the idea that we can and will move at any meeting.”
This means the Fed can raise rates at any meeting. That’s easy for him to say now because the Fed will be raising rates in December. It’s highly unlikely that the Fed will hike at every meeting in 2019. I will trust the Fed funds futures market until the Fed surprises us with a hike.
If the Fed goes with surprise hikes as the economy continues to slow in 2019, it will only provide support for the bearish thesis on stocks.
Even though Powell said every meeting is live, the Fed funds futures market showed the chance of a hike in December fell on Wednesday from 75.8% to 72.3%.
This probably occurred because it was a ‘risk off’ day. Once it falls below 70%, I’ll rethink my expectation for a 20 basis point hike. The Fed is now expected to hike rates one or two times in 2019 assuming the hike in December goes through.
Each meeting won’t be live as there will be fewer hikes next year than this year.
As you can see from the chart below, the Fed is repeating the same policy mistake now as it did in 2005.
Housing market affordability plummeted while the Fed raise rates. This won’t end as badly as that cycle. There aren’t as many variable rate mortgages which will become more expensive when rates go up.
Powell - Treasury Update
The 2 year yield hasn’t followed Powell’s lead. That rate is currently 2.87% which is 10 basis points below its recent peak.
10 year yield is 3.13% which puts it 26 basis points above the 2 year yield. The 10 year yield fell sharply during the volatile stock market action on Wednesday. But it regained most of the decline before the close.
There will be a point in the future where a stock decline causes treasuries to rally. At that point, the curve might invert if the Fed is still raising rates.
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