WE Invest

Truce or dare

You would think as equity markets wrap up one of the best first halves in decades that we would be ecstatic. The problem is, we’ve been here before. We have seen new highs within 3% four times in the last 17-months only to give it up again weeks later. Why? Well, we think it’s quite clear; uncertainty and exhaustion.

Trade war, markets sell off. Trump/ Xi meeting, markets rally. Trade war, markets sell off. Trump/ Xi meeting, markets rally. Trade war, markets rally. Trump/ Xi meeting, markets sustain rally.

Which of these is different from the other? The constant barrage of erratic policy is easy to leave investors tired and uneasy. So much so, the Federal Reserve has changed course.

Just six months ago, Central Banks made it seem like a decade of easing was behind us. Now, on the eve of the expansion’s 10-year anniversary, we appear to have the likelihood and more importantly the indication that global synchronized easing is again upon us. Yet, this time it isn’t in reaction to a recession or to the worst financial crisis since the Great Depression, but rather, the fear that growth is slowing and high levels of uncertainty, partly due to poorly managed foreign economic policy and protectionism.

The Fed removes “patient” from its guidance.

The Fed is a democracy and will require all members to agree on a rate cut. This was the first time Powell had a dissenter, while eight members see no change in rates his year, another eight see a cut and one sees a hike. Even those who see no cut agree the case for a cut has grown. While this division should spark uncertainty, the market has taken the Fed’s words as a highly certain rate cut to come. The Fed isn’t the only central bank concerned over a global slowdown as many have tilted or signaled easing. We saw this most recently from Mario Draghi, president of the European Central Bank, who said if the economic situation doesn’t improve a new round of easy money “will be required”.

While the Fed has lost patience, China-Xi can be very patient, and they have already begun to stimulate the Chinese economy.

Reviewing the outcomes:

  1. US-China No deal at G20, Fed Rate cut in July: This seems to be the most likely in our opinion.
  2. US-China deal at G20, Fed Rate cut in July: While we believe this is unlikely it would also mean we should have bought, bought, bought equities. We believe a China-US deal will postpone a rate cut until at least the September meeting.
  3. US-China deal at G20, No Fed rate cut in July: This too seems in line with the Feds “watch the data” mantra. If there is a deal the Fed would likely want to wait to see economic data and might again be “patient”.
  4. US-China No deal at G20, No Fed rate cut in July: Not very likely. The Fed has committed itself to supporting the expansion.

Patience is an art. Keeping emotions at check at times like these is critical. We hope the Fed too exhibits patience as it will likely be better for the long-term. Much has been mentioned about an inverted yield curve where shorter rates are higher than longer rates. The interpretation is that investors believe growth is weakening. Typically, the yield curve inverts at a much higher interest rate than we are at currently. In other words, markets have predicted and invested as if rate cuts are coming because they don’t see growth long term. This typically happens when rates are much higher than the Feds targeted 2.25-2.5%. To start cutting at these rates is also troubling because if we lean into a recession the Fed doesn’t have much more to cut to stimulate the economy. But as the Federal Reserve said Friday it “will act as appropriate to sustain the expansion.” Undoubtedly, the risk is this will lead to overheating and bubbles.

While we try to balance patience, in a world where it seems to be lacking, our models are straddling between missing the upside and minimize the downside. The current administration, the Fed, and the lengthy expansion have provided us with many risks. These risks create several uncertainties that are difficult to manage at a portfolio level: War with Iran, Trade Wars, discrediting the Federal Reserve through tweets, historic tax cuts ballooning deficits, and overheating markets.

As the media and likely the President celebrate the unofficial 10-year anniversary of economic expansion we position ourselves patiently. While our strategic allocations haven’t changed, we tactically took profits in April and we are still in a more defensive position today. We’ll look to take advantage of any sell off and prefer to focus on downside risks.

As always, if you have questions of concerns reach out to our team and we will be happy to chat with you. Have a great summer.

Eddy Augsten and your WealthEngage team.

Any opinions are those of WealthEngage and not necessarily those of Raymond James. Expressions of opinion are as of this date and are subject to change without notice. There is no guarantee that these statements, opinions or forecasts provided herein will prove to be correct. This material is being provided for information purposes only. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Investing involves risk and you may incur a profit or loss regardless of strategy selected.