Stocks End Flat After Fed Cuts Rates

Wild Action After Fed Statement: Stocks End Flat

S&P 500 was down slightly before the Fed meeting. There wasn’t much of a reaction to the statement. Then Powell spoke which created volatility. S&P 500 bottomed at 2,981. Then it spiked in the last hour trading. It increased 0.85% to close the day up 3 basis points (3,007). 

Considering that the market is overbought, this wasn’t a bad reaction. Personally, I’m less concerned with the Fed than I am about the economic data. If the economy falls into a recession, then nothing the Fed can do will prevent stocks from falling. If the economy improves, earnings growth will be solid in 2020 and stocks will have room to rally.

Global central bank easing certainly helps America though as the global economy has been bringing America down. As you can see from the table below, most of the recent global central bank actions have been cuts. I’m actually not disagreeing with the stock market’s reaction on Wednesday. My disagreement is with anyone basing their macro view on whether the Fed cuts one more time this year. It’s not a huge deal. The trade deal is a bigger issue.

Nasdaq fell 0.11% and Russell 2000 fell 0.63%. Even though the Russell 2000 fell, the KBW regional bank ETF rose 0.72% on the back of the hawkish Fed guidance. Personally, this Fed meeting changed nothing for me as I think it’s still likely the Fed cuts rates one more time this year. 

Regional banks rallied despite the flattening of the yield curve which I will discuss in the next section. Financials and the utilities were the best sectors on Wednesday as they increased 0.43% and 0.47%. Energy sector was the worst as it fell 0.42%. Oil prices are now only at $58.20 which is way below the peak of $62.90. Oil is near where it has traded for the past few months. That spike was a temporary blip.  

Fed Flattens The Curve

It's not clear what the Fed’s plan was heading into this meeting, but the end result worked out well. I don’t see a recession coming soon, so there’s no need to cut rates significantly. Fed is reacting to a normal slowdown which could turn into a recession. Odds of a recession increase if the planned tariffs are applied. 

Fed kept the curve flat which means it doesn’t signal a recession yet. 10 year yield is now at 1.78% and the 2 year yield is at 1.75%. The Fed doesn’t control the long end of the curve. It will steepen if nominal growth expectations improve. That example of a steepening shouldn’t be in tune with a recession. There is currently a 57.9% chance of one more cut this year. If the Fed cuts too much, it could have an inflation problem if there is a trade deal and a cyclical upturn.  

First Q3 Earnings Look Good

It’s way too early to utilize Q3 earnings as a viable indicator, but it’s worth nothing that the first 4 firms to report results had earnings growth of 1.36%. Even though the average EPS surprise was -0.15%. Q1 and Q2 had higher surprise rates after the first four firms reported, but their growth rates were -6.11% and -5.16%. So far, so good for the Q3 earnings season.

Industrial Production Signals Stock Market Weakness

Industrial production report can be looked at 3 ways. You can look at monthly growth, yearly growth, and the 2 year growth stack. Only growth on a yearly basis looked weak. That explains why using yearly growth brings you with weak expected returns for the S&P 500. Only other times yearly industrial production growth fell below 0.4% while the unemployment rate was below 5% in the past 50 years were April 2008 and January 2001.

As you can see from the table below, in the 3 months after this signal has gone off, the S&P 500 has fallen 3.3% in the next 3 months and only increased 25% of the time. Most of the readings were from the 1950s and 1960s. While industrial production weakness doesn’t always signal trouble, it’s daunting when the unemployment rate is low because that signals the cycle is almost over. I still don’t see reason to call for a recession, but it’s obvious the data doesn’t look kindly at this combination.

Late 2019 Housing Market Recovery

Generally, you don’t see a recession with the consumer doing well and the housing market recovering. Even though some say the yield curve inversion means a recession is coming, the decline in the long bond has done wonders for the housing market.

MBA mortgage applications report from the week of September 13th supports the case that the housing market is heating up. Composite index fell 0.1% weekly after a 2% increase. It only fell because refinancing was weak. Refinancing index fell 4% weekly after increasing 5%. 

Purchase index was fantastic as it increased 6% after rising 4%. That brought the yearly growth rate to 15%. Despite the recent rise in rates, the purchase index has had 3 straight fabulous readings in a row. I now see the housing market helping GDP growth for the first time in 6 quarters. That could boost GDP estimates to above 2%. The economy wouldn’t be in a recession without housing. But this improvement can certainly prevent the slowdown from deepening.


Fed made the right move by not guaranteeing another rate cut this year because there can easily be a trade deal which makes one less necessary. The economy is in a slowdown, but Q3 GDP growth might not be as terrible as I thought if the housing market continues its strength. 

While a low unemployment rate and a weak industrial sector is a bad combination, a strong housing market covers for that weakness. 2H 2019 will probably be the trough of the manufacturing slowdown. The global economy will be helped by central bank easing in 2020.  

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