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Markets climb “wall of worry” to near record high

SEP. 16, 2019


  • Equity markets rallied to within 1% of an all-time high following the third-straight week of gains. Beyond the market approaching record highs, the dynamics underlying the rally are increasingly healthy, including healthy breadth and new high data. Historically, when market breadth and new highs are strong, the returns over the following six and 12 months are above average. There was a notable shift from growth to value, with the Russell 1000 Value outperforming the Growth by 3% last week. During the current cycle, growth has outperformed value by roughly 45%. Small caps were also strong, outperforming by nearly 5%. Through the cycle, small caps have performed in line with large despite 15% underperformance since last July.
  • Geopolitics had been fading as a driver of Wall Street’s “wall of worry” recently, though it reignited on Saturday as Saudi Arabia’s oil facility was attacked and roughly half of their production and nearly 6% of global supply were taken off line. Crude initially jumped a record 19%, though came well off the high. While Saudi officials were optimistic on timing of restoration, President Trump announced the release from the Strategic Petroleum Reserve if needed. The Iranian-affiliated Houthi rebel group claimed responsibility, though the U.S. directly blamed Iran. Tehran rejected those claims, and both sides seem prepared for conflict. This comes less than a week after tensions between the two sides calmed with the removal of John Bolton from the position of National Security Advisor. The equity market reaction was muted, reflecting a more optimistic stance among investors.
  • The FOMC meets this week, and while the odds continue to favor a cut to rates, the odds have fallen from a 100% last month (22% chance that it is a 0.50% cut) to only 77% now (0% chance of 0.50%). A reading of core CPI last week of +2.4% from a year ago was the fastest rate of growth since August 2008. This jump complicates things for the Fed, as low inflation provided the primary cover for rate cuts. Following the meeting, close attention will be paid to comments by Chair Powell to see if his phrasing of a “mid-cycle adjustment” changes. Through next April, the odds of two-or-fewer cuts is 51% versus 49% of three-or-more. A month ago, the split was 14%/86%. Despite this adjustment, the S&P 500 has gained 4%, perhaps signaling that the market is less rate cut dependent.

Other Topics

  • Trade rhetoric between the U.S. and China has improved in recent weeks, with President Trump signaling that a partial and temporary deal could be considered, and China indicating they are willing to boost agricultural purchases and limit retaliatory tariffs. Economic data in China is slowing, with industrial production growing at the slowest level in 17 years. Fixed investment and retail sales also disappointed to the downside, as Premier Li admitted that it would be “very difficult” to maintain 6% economic growth. The target for 2019 is for growth of 6.0-6.5%, with second quarter growth falling to a 30-year low of 6.2%.
  • The Trump administration teased a middle tax cut plan that Trump said will be “very substantial” and “very, very inspirational.” This “Tax Cut 2.0” follows the decision not to pursue a capital-gains tax cut by indexing to inflation or a payroll tax cut. The options for additional tax relief are limited given Republican resistance to offset middle-class tax relief with higher taxes on the wealthy. The current fiscal year ends this month, and the budget deficit is tracking to $1 trillion, the largest since 2012. While the deficit as a percent of GDP is not at an extreme, it is rare to have such a large deficit with unemployment at such a low level, potentially limiting the scope of fiscal stimulus in the next downturn. This year’s deficit will be 4.6% of GDP, compared with 2.3% in non-recession years dating back to 1955.
  • The ECB voted to cut its deposit rate by 0.10% to a record low of -0.5% and said it would restart bond purchases at a rate of €20 billion per month in response to sluggish growth, stubbornly low inflation and Brexit uncertainty. As he announced the monetary stimulus package, ECB President Mario Draghi also emphasized the importance of fiscal stimulus and structural reforms, essentially saying that only a combination of both monetary and fiscal stimulus could revive European growth. Draghi is set to step down on October 31, when he will be replaced by the head of the IMF, Christine Lagarde.

What to watch

  • The FOMC announcement on Wednesday will drive the news cycle, though the Bank of Japan is noteworthy as well. Economic data include industrial production Tuesday, housing starts Wednesday and existing home sales and leading indicators Thursday.

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  • This material is not a recommendation to buy, sell, hold or roll over any asset, adopt an investment strategy, retain a specific investment manager or use a particular account type. It does not take into account the specific investment objectives, tax and financial condition, or particular needs of any specific person. Investors should work with their financial professional to discuss their specific situation.

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