Explaining the stock market’s recent gyrations is no easy task. At the end of last week, which concluded 6 straight weeks of the Dow Jones Industrial Average dropping, ending June 1
st, investors’ were thinking it’s time to sell everything to lock in 2019’s gains for the year. And then they’d come back when the tariff induced sell off is over, or at least until they have greater visibility on negotiations with our trading partners like China and Mexico. Now that market talk is that the Mexico import tariff of 5% is going to be delayed, if not dropped entirely, stocks are on the mend. But they were on the mend for a few days before that, so the market talk of delayed or dropped Mexican import tariffs really don’t explain the whole move higher this week. Read on to find out what the catalyst was.
Not one to be prone to hyperbole, I do have to push myself to use stronger words to describe this week’s up move. It was a rip-roaring, rocket ship, explosive move higher. But rather than enjoying it, investors this week are scratching their heads. Investor trust is shaken because rather than seeing the rally this week as soothing, it is seen as a stock market that is out of control. No one who works their ass off to sock away money after paying bills and taxes wants that; a Russian roulette-style of outcomes on a daily basis.
I’m well aware of the latest economic statistics that we asset managers and planners hang our hats on. And believe me, most of them are not painting a pretty picture of the economy right now. If you want a quick summation, read the rest of this paragraph. If not, just skip down to the next one. Here goes: Rising auto loan delinquencies and (much) lower auto sales, housing isn’t reacting to plunging interest rates the way it used to, retail apocalypse (tons of store closures), indebted corporations, yield spreads are widening, stock buybacks are slowing, and job creation is slowing - fast. The bond market is signaling an economic slowdown and German Bund yields are at zero or negative. The European Central Bank is out of bullets. Sanctions against Iran have taken millions of barrels of oil off the market, yet the price of oil keeps dropping. Oh, the tariffs too. Just before stocks started to drop 6 weeks ago, some investors were like “the China trade war really isn’t that big of a deal”. But a down market could impact your psychology and change how you view things. It’s a big deal and the next stock plunge is a tweet or sanction away.
The misguided threat of an across-the-board Mexican import tariff wasn’t just the last thing to weigh on stocks; it sparked the realization of how investors, professional and ordinary alike, have absolutely nothing to judge anything by and that nothing you know means anything anymore when it comes to investing.
Well, except for one thing. You don’t fight the Fed. The Federal Reserve chairman and vice chairman, Jerome Powell and Richard Clarida, respectively, have gone out of their way to assure investors that cuts to short term interest rates would happen if the U.S. economy continues to weaken. That’s why stocks are up today despite the big miss in the Labor Department’s non-farm payroll report this morning. Its miss reinforced investors’ expectation that the “Fed put” is alive and well.
Billionaire hedge fund manager, Stanley Druckenmiller, said something on CNBC this morning that I thought was such a great way to describe the mechanism in which interest rates impact investments. I'll paraphrase: "I deeply, deeply believe in a capitalist system, you need a hurdle rate for investment and if that rate is not up there, somewhere around 3 or 4 (percent), people are going to get crazy, investors are going to get crazy, corporations are going to get crazy, zombie (companies) are going to stay in business"
My interpretation: interest rates are like a hurdle that an investment’s expected rate of return has to clear. A low hurdle is obviously easier to clear than a high hurdle. When the hurdle is really low (think low interest rates), almost any investment can clear it and that’s what causes stocks to go up and is the root cause of asset bubbles.
Turns out that Powell is playing from the same playbook as Bernanke and Yellen. Make no mistake about it; if not for Powell stepping in, the stock market would be continuing on its way lower. For this stage of the long running bull market, the more things change, the more they stay the same. How could stocks not go up in that environment?
Have a great weekend!
Video below for parents who want to save for their child(ren)'s college education. I'll have more videos like this coming out soon: