Stock markets in the U.S., as measured by the Standard and Poor’s 500 (S&P 500), continued their march to recovery during the second quarter. Recently, U.S. stock markets have moved to new record highs; however, they are still only slightly above January 2018 levels. The upward march was briefly interrupted by a 7-10% pullback in May due to the increased trade tensions between China and the United States. Markets recovered in June as the Federal Reserve fanned the flames of a potential rate cut later this year. Investors’ eyes will keenly focus on the two-day Federal Open Market Committee (FOMC) meeting which concludes July 31st. The market is pricing in close to a 100% chance of at least a 25-basis point (0.25%) rate cut this year. Market participants have become so focused on Fed action that good news is being viewed as bad news since it could hurt the chance of a rate cut. We believe there is a possibility the Fed will not deliver, which could lead to investor disappointment.
To get a handle on the Fed’s decision, one must consider their “dual mandate.” The Fed’s mandates are to maintain healthy labor markets and to control inflation. The labor market still looks healthy, with an unemployment rate of only 3.6%, nearly a 50-year low. Inflation, as measured by the Consumer Price Index (CPI), has also surprised on the upside. Core inflation (excluding food and energy) rose 2.1% year-over-year; while wage gains are improving, and businesses are starting to raise prices. Neither of these data points scream rate cut. Besides, we are skeptical about the actual impact a rate cut may have in bolstering the economy. Chairman Powell noted during congressional testimony that the current economic “uncertainty” is mainly due to trade; it is not a function of rates being too high.
While the meeting between China and the United States at the recent G20 summit resulted in a temporary cooling of tensions, it did nothing to reduce currently imposed tariffs. Both sides have indicated much work remains to be done for a deal to emerge, and neither has committed to a deadline. Failure to reach a trade deal will likely keep corporate spending depressed. In addition to China trade concerns, the United States is still at odds with the Eurozone and India, and the passage of the USMCA remains bogged down. All of this uncertainty will weigh on the economy.
Despite robust unemployment and moderate inflation numbers, late-cycle concerns have begun to emerge. Estimates for GDP growth in the second quarter of 2019 came down as cost pressures, trade tensions, and global uncertainty took their toll. While we don’t see an immediate catalyst for a recession, the economy’s margin of error is slim. Markets seem to have priced in near-perfect policy performance, which increases the potential for disappointment. Investor sentiment has reached the extreme optimism zone – a contrarian indicator – according to the Ned Davis Research Crowd Sentiment Poll. There is concern investors are ignoring burgeoning risks.
While U.S. stocks are trading at close to record highs and investors are bordering on exuberance, we believe the probability of disappointments may be rising. Now is a good time for investors to revisit their portfolio holdings. If stocks were purchased during last year’s correction, portfolios could be overweight in stocks after this year’s rally. It is also an opportune time for a risk tolerance review to ensure you are not chasing returns in an overly optimistic market. As always, we are happy to discuss these or any other topics.
The views and opinions expressed are of Persium Advisors, LLC. This commentary is provided for educational purposes only and should not be construed as investment advice. Persium Advisors is an investment advisor firm located in Atlanta, GA.
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