It all adds up. One, two, three, four. This week a combination of data points caused the equity market to rip and the 10-year US Treasury yield to fall below 2.1%. Following the tumult of threatened tariffs on Mexico and rising anti-trust attention to the technology sector, Fed Chairman Jay Powell gave markets the faith that the Powell “put” is solidly in place by signaling that the Federal Reserve stands ready to cut rates if needed. Typical of an emotional environment, the S&P 500 ripped 2% higher on Tuesday and continued up through the rest of the week. Classic “bad news is good news” mentality ended the week on Friday when the jobs report showed a paltry 75k jobs added – about 100k short of expectations. Naturally, both bonds and equities rallied as they pulled forward potential Fed rate reductions. In the past six months, the Fed futures curve has gone from pricing in two rate hikes in 2019 to today where there is an expectation of three rate cuts this year followed by a fourth in January 2020!
From our view point, we think the equity market is overly optimistic. Let’s put it this way, if a data-dependent Fed has to cut four times in the next seven months to support their dual mandate of full employment and price stability then we have a serious growth problem on our hands that would likely be discounted in equities.
Since the beginning of 2018, there has been a lot of distance traveled (equity markets going up and down) without a lot of cumulative return ground gained. All of the fits and starts of the equity market are a signal of uncertainty about the future – and the uncertainty starts to weigh more over time. After 18 months of back and forth, confidence deteriorates. Confidence of business leaders unable to make long-term plans for capital expenditures. Confidence of home buyers reticent to make the leap despite much lower mortgage rates. Confidence of consumers who may be thinking that the job picture has only one way to go.
In a period such as this, we remain steadfast in our approach having positioned for this type of market ready to tip one way or the other. Keep your risk level in check with your time horizon, your investments focused on quality cash flow, and your emotions prepared to do the hard math when the valuation opportunity eventually comes.