After beginning July with a strong posture, markets seem to be pausing to catch a breath. Domestic equities slipped -1.2% during the week ending July 19, effectively halving the month-to-date performance. It is challenging to point to any single factor or headline, but perhaps most notable is the reality that corporate earnings being reported for the 2Q period are soft. When combined with the reality that the market as a whole is up handsomely YTD despite what seems to be persistent negative headlines (be it trade, geopolitical tension, yield curve inversion, etc), it’s not hard to understand why the investment community’s prevailing sentiment is that the good times will not last.
From a fundamentals perspective, we’ve highlighted soft corporate earnings picture. And for weeks, we’ve been handed weaker than desired data on a number of other economic measures around the globe. But the July data is firming a bit to support the idea that while the global economies are slowing, a soft-landing looks increasingly possible vs an abrupt contraction. The reality is that central banks are jockeying to extend the cycle. The US Fed is strongly communicating that it will cut rates, and other central banks are following suit. It is also important to acknowledge that while manufacturing data shows weakness, economies like the US and Europe are increasingly dependent on services and consumption. In that regard, these major economies remain in good shape. Last week’s US retail sales data supports this idea, with the fastest six-month growth rate on record. But wait… last week also brought encouraging news from manufacturing and export-driven economies beneath the surface. Headlines told us that 2Q GDP of 6.2% in China was the slowest since records began 27 years ago, but data for retail sales, industrial production, and fixed asset investment all showed improvement. Also interesting: a basket of stocks that has been closely tied to the ebb/flow of sentiment over the US-China trade dispute suggests that constructive progress may be occurring in recent days.
As we quickly approach the end of July, seasonality is usually believed to be a slight headwind. That is virtually irrelevant to our thinking of investing a portfolio to achieve long-term goals as fundamentals are far more meaningful over measurable time horizons. Still, there are some overbought conditions as a result of how strong was the 1H and start of July that need to be relieved through either price and/or time. On the immediate horizon, the Fed is faced with a challenging task next week as it is expected with near certainty to cut interest rates. Some investors are of the perspective that this cut should be not just a quarter-point, but a rather sharp 50bps vaccination. From our perspective, that might be more troubling than helpful considering the economy is still making forward progress; such an aggressive cut could be interpreted as the Fed being aware of something frightful under the surface. It would also weaken or reduce the tools available to help stimulate the economy should a more dramatic slowdown begin to unfold. But market participants looking for such a cut could be disappointed if it is not delivered, or the accompanying statement does not clearly communicate additional cuts will be coming. On the other side of that, talking heads and pundits have been hard at work questioning the logic of rate cuts when the stock market is so close to all-time highs. It is probably these same people that would like to see the economy struggle ahead of the election next year for political reasons. Interesting however is that the current rate-cut backdrop is actually not uncommon; historically the Fed has cut rates in the year ahead of a Presidential election (which we are) far more than it has hiked. And, since 1982 the Fed has cut interest rates 21 times when the stock market was within 2% of a 52-week high (2007 was an exception, but more often than not the cut was bullish).