Monetary Disconnect


I commented here last month that we finally had a solid negative month for the year. In fact, you'll see in the Drawdown Table above, that May registered a greater than 5% decline from the high. Less than a month later the S&P 500 registered a new all-time high, and as of the time I'm writing this at least has reversed May's decline.


I don't have any explanations for this; it's just how the markets naturally are: volatile, all over the place, often disconnected from reality.


Much of the market's turnaround in June can be explained by economic news. Specifically, we've now done the full 180 on interest rate expectations. Remember that how the markets (in particular the bond markets) react to interest rates has less to do with what the rates actually do but what they're expected to do. Just this past fall the 10 year U.S. Treasury bond was on the up and up, breaking the 3.2% level and thus worrying rate-watchers, as higher rates will eventually slow down the economy. As expected, the U.S. Fed hiked their overnight rate in December, to the chagrin of the markets. Fast forward to today and the 10 year has plunged to 2% and now they're talking about possible rate easing, both in Canada and the U.S.


Yet the U.S. economy remains fairly strong, stocks are near all-time highs, and the normal course of economic cycles would dictate that rates need to go higher still, to control inflation, until we start seeing the signs of recession and then they should decline.


Brian Wesbury writes an excellent weekly newsletter that comes out each Monday morning, and the most recent one muses a bit more about the above. He also refers to a number of instances in the past when the Fed made outright errors which ended up leading to recession. This time around though, if you ask me, what I really worry about is the eventual inflation that will result from a Fed that's unwilling to tighten, along with the higher import prices Americans will face from a combination of declining currency (tends to be correlative with interest rates) plus Trump's trade battles.


On a similar topic, I've been remiss again when it comes to sharing our own Robert Jukes' excellent weekly Global Strategy Notes. His June 23rd Note also looks at monetary policy and in particular--presuming the Fed and other central banks continue to be so reluctant to tighten--this scary new thing called "Modern Monetary Theory" proposed by far-left politicians.


Now, if the Fed does follow through with monetary easing can it be so bad? More cheap money, more economic growth, more new highs in stocks?


I can tell you someone who will be really happy, and that's President Donald Trump. In fact, with the 2020 election campaign more or less kicking off now, at least in the consciousness of average Americans, with the recent first round of Democratic debates, one has to wonder if all of this is part of his strategy.


For Trump to have any chance at re-election, the economy has to be rip-roaring around 14-16 months from now. Though Trump knows very little else about economics or business, he does know that lower interest rates boost the economy and stocks, as he proved in 2015, when he accused the Fed of helping out Obama by doing the same thing (during an actual economic slowdown).



This has Trump now protesting rate increases, as he did in December, and calling for lower rates; effectively more fuel for the economic fire. He's even gone so far as to suggest that the ECB's Mario Draghi should be Fed Chairman instead of Powell, presuming Draghi would bring Europe's 0% interest rates with him, regardless of the economic landscape in America (on the contrary, if Draghi is like the many other European central bankers that came before him, he learned a thing or two about hyperinflation in history class, and is far more likely to tighten out of fear, as the ECB mistakenly did in 2011).


‘Here’s a guy nobody ever heard of him before and now, I made him and he wants to show how tough he is.’’

-The President of the United States describes the Chairman of the Federal Reserve


But wait, if the President is so concerned about a strong economy and strong stock markets going into a re-election year, couldn't he just cool it with all the trade protectionist talk that keeps causing the market to tank (as it did in May) and is having a noticeable detrimental effect on U.S. GDP growth? Unfortunately, no, because that is also core to him having any chance at re-election. He needs certain swing states--the "purple" ones that are attainable--and each of those states has trade issues, where protectionist rhetoric wins the low-information voter.


Think about Pennsylvania and steel. Manufacturing in Michigan and Ohio. Trump even rattled sabers on dairy with Canada, in order to preserve the dairy farmer vote in Wisconsin. Notice that he hasn't made a peep about softwood lumber though... (Washington is a solid blue state). For this reason, Trump needs the Fed to lower rates--to offset the economic damage his trade protectionism does--and he'll do what he can to get his way. It seems to have become self-fulfilling anyway, as the narrative (especially after weak job numbers) now is that the U.S. economy is slowing and in need of stimulus. Weak economic figures are once again fueling stock market growth as investors are coming to expect those rate decreases.


So anyway, I don't usually make market prognostications, however, I'm going to put forward a theory here; I guess it's a prognostication. Trump gets his way, rates go down, economy goes on a heater through 2020. He likely also will tone down the anti-trade rhetoric too, to further boost the economy while still being able to tell his voters "look, I tried harder than any other President..."


Sentiment Disconnect


Another interesting observation of the overall markets is investor sentiment. Of note, Bank of America Merrill Lynch's Global Fund Manager Survey for June apparently came in more bearish than at any time since the 2008 financial crisis (Bloomberg Article).


Some bullet points about the survey below, courtesy of our Lead Portfolio Manager, Kevin Vandermeer:

  • Bank of America Merrill Lynch described its June Global Fund Manager Survey as the most bearish since the global financial crisis, citing concerns around the trade war, recession risk, and monetary policy.

  • The FMS cash level increased 1.0pp to 5.6%, the biggest jump since the 2011 US debt ceiling crisis.

  • Equity allocation fell by second-most on record, with the lowest relative allocation of equities to bonds since May-09.

  • Global growth expectations fell by 46pp m/m, a record decline, to a net 50% of investors expecting global growth to weaken over the next 12 months.

  • Around 87% of investors also said the global economy is in the late cycle, a record-high reading.

  • Global EPS expectations fell by the second most ever, down 40pp m/m to 41% of investors expecting a deterioration in profits over the next 12 months.

  • Trade War was the biggest tail risk for the 14th time in the past 16 surveys, increasing 19pp to 56%, the highest level since Jul-18 (60%). Monetary policy impotence was second-biggest tail risk

  • Investors said the S&P 500 level for the Fed put was 2430, and the level at which Trump cuts a comprehensive trade deal of 2350.

  • Long US Treasuries was the most crowded trade for the first itme, while long US tech fell to second.

  • Around 45% of investors want companies use cash to de-lever, down 1pp m/m. Preference for capex was down 2pp to 33%, while returning cash to shareholders of 13% was up 1pp m/m, just off the Feb-19 record-low of 10%.


I think we're in a fairly unique spot right now, as usually sentiment follows the markets, it doesn't lead. So usually such pessimism would come after a market decline, not when the markets are near all time highs. Can we presuppose then that sentiment will shift to be more positive, after the strong month of June we've had, thus powering a further rally in stocks? I don't know really.


My own experience investing has been that usually one is more successful investing when pessimism is higher rather than lower, so I'm actually liking this. 

Tweets and Articles for June


Whenever I read something good, I tweet it out from @CGWM_Muhs. Follow me on Twitter if you want live updates of what I'm reading. For those who don't have the time for Twitter, a short list of some of the best stuff I read below.


More Stuff


Capital Group's Mid-Year Outlook CLICK HERE


RBC Global Asset Management's One Minute Market Update for Spring 2019 CLICK HERE

RBCGAM's One Minute Market Update is a short quarterly overview of the markets. What I especially like is their "Fair value range" charts on the right side, taking very long term views of various markets and where stocks are trading relative to long-term fair value.


JP Morgan's latest Guide to the Markets CLICK HERE

This 60+ page slideshow is chock full of charts, facts and figures, that give you pretty much everything about everything you could possibly want to know about the economy and markets. Want to know how U.S. stock valuations compare either historically or with the rest of the world? Want to know how much the U.S. government is borrowing? You'll find it all here.

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