Reaching For A Record: Stocks Approach All-Time Highs Amid Rate Optimism

Now that the Fed meeting has come and gone with no rate cut, a lot of people are asking themselves, “What’s next?”

Well, if you can forget about the Fed for a bit, there’s a bunch of stuff in the headlights, especially next week. That’s when we have the G-20 meeting featuring President Trump and Chinese President Xi, and the OPEC meeting featuring major oil producers talking about how to boost the sinking price of crude.

Speaking of crude, it’s up sharply this morning with no action from OPEC needed. This might be partly due to hopes for monetary easing, which tends to help commodity prices. However, crude also got a lift from another clash in the Persian Gulf, with a U.S. drone shot down by Iran. Another factor that may be helping crude early Thursday was a bigger than expected drop in U.S. stockpiles last week. Lately, crude hasn’t been very good at holding on to gains when geopolitical events occur, so we’ll see if this time is any different.

While the OPEC and G-20 meetings are still a bit in the future, and it’s way too early to make any predictions about how the trade talks might go, this morning saw the end of two other meetings: The Bank of Japan (BoJ) and Bank of England (BoE). Neither central bank changed rates, but the BoJ hinted that it’s ready to ease policy if necessary. That helped lift Japan’s major stock index earlier Thursday. Japan’s short-term rate target is still below zero.

The BoE also kept rates steady, but stirred up some negative currency trading by forecasting zero growth for the economy in Q2. That’s put some pressure on the British pound today. Remember, it might not be “next,” but the Brexit deadline is Oct. 31, and fears of a “no deal” Brexit seem to be rising.

In the meantime, U.S. stocks had a positive tone early Thursday, with the S&P 500 Index (SPX) and the Dow Jones Industrial Average DJI both nearing all-time highs. It appears that markets like the implication of a possible Fed rate cut, and stocks aren’t the only instrument reacting to the Fed’s more dovish language. A lot of commodities are rallying along with crude, and the dollar has weakened. Rate cuts often hurt currencies and raise commodity prices, so today’s early action is in line with what might be expected.

Slack Gets Ready to List

Another near-term thing to consider watching is the expected direct listing today of Slack. This is different than an Initial Public Offering (IPO). The IPO market has been buzzing lately, with many newly public companies seeing double- or even triple-digit gains, so it might be worth keeping an eye on Slack today to see how it performs vs. the recent IPOs. As a reminder, a direct listing means the company doesn’t issue any additional shares or raise any new money. The stock simply gets listed, in this case on the New York Stock Exchange (NYSE).

From a technical standpoint, it might be interesting to see if the SPX can close above the old record high closing level of 2948 posted in late April. An achievement like that might signal more positive sentiment ahead.

There are also some earnings in the news today, Oracle Corporation ORCL reported late Wednesday and got a cheer from investors. Shares rose as much as 7% in post-market trading after the Technology company beat third-party consensus on both earnings per share and revenue. Analysts had widely expected ORCL to see revenue drop in its fiscal Q4, but it rose 1%. The company’s cloud business looked strong.

This morning brought earnings from an entirely different part of the economy when retail food store Kroger Co KR released results. This is a stock that’s been getting beaten up so far this year, as the whole brick-and-mortar grocery industry is in what Barron’s calls a “food fight” amid intense competition. KR reported earnings in line with third-party consensus estimates and revenue a tad above the average Wall Street projection. However, that revenue was down slightly from the same quarter a year earlier.

Defensive Posture Still Looks Popular

You never want to analyze just an hour or two of market performance and come to any big conclusions, but it is interesting to see how sectors acted yesterday after the Fed meeting. The strongest sectors continued to be the “defensive” ones like Utilities, Health Care, and Staples, though Technology also got a good bid as semiconductor stocks held on to recent gains.

The non-cyclicals mentioned above are some of the best performers of this recent rally, and that might be something to consider. In a really strong market environment, it’s often positive to see muscular sectors like Financials and Tech leading the way. That hasn’t really been the case over the last month, though Materials are performing well. It is positive to see, though, that in the last week we’ve had some strength in Consumer Discretionary and Industrials, as well as Technology. So maybe the cyclicals are re-emerging.

As we noted yesterday, the Fed’s decision to put off a rate cut while still expressing concerns about the economy  shouldn’t necessarily be a reason to celebrate. The Fed basically confirmed what a lot of analysts have already said about the economy slowing down. A rate cut would be a response to a softer economy, and when the economy weakens, that doesn’t tend to be a good situation for the stock market. That might help explain the defensive posture many investors have taken recently.

This morning, odds of a July rate cut stood at 100%, according to the CME futures market. Odds for rates to drop 50 basis points between now and September were 85%. Historically, numbers this high have often proven correct, though there’s no way to really be sure. However, if the numbers are right, it looks like we’re headed for the first rate cuts since the markets and economy were getting slammed back in December 2008.

Sectors and Rates: Something to consider as the Fed turns more dovish is how this change in tone might affect sectors. Utilities and Health Care were two sectors that showed particular strength over the last month, and that might reflect hopes that dividend-yielding stocks could do better in a lower-rate environment. Financials, though, typically don’t do as well when rates start dropping. Investor worries about the sector might be showing up if you look at the last month and the last three months of Financial performance. The sector trails the broader S&P 500 Index (SPX) in both of those time frames. Remember, the Treasury market inversion that happened last month didn’t just go away. Three-month yields still outpace 10-year yields, a sign that investors are piling into longer-term instruments even at lower rates. This isn’t a normal situation, and almost certainly isn’t a healthy one for banks. 

Lending a Hand?: Meanwhile, if the Fed goes ahead and lowers rates next month, maybe it could slow the flow of overseas cash into U.S. Treasuries. Perhaps that could even help lead to a bit more economic vigor for Europe, where much of that cash appears come from. Just a quick review: European bond yields are extremely low, with the German bund recently hitting a record low yield of around minus 0.33%. That means people buying these instruments are paying to lose money. That’s probably one reason why so much money has flowed into U.S. Treasuries over the last month. 

However, when U.S. Treasuries rally, their yields go down. Recently, U.S. 10-year Treasury yields fell to 1.97%, from 2.68% at the start of the year and above 3.2% last fall (see figure 1 above). That means investors are getting less for their money, though the yield still seems pretty high compared to negative yields in Japan and Germany. Still, falling U.S. rates just might give overseas investors a pause, and maybe cause them to not invest as much in U.S. Treasuries. It’s a long shot, but maybe some of that cash could end up being spent or invested by overseas investors in their home countries, instead of here. 

Greenspan Revisited: With Fed Chair Jerome Powell reiterating yesterday that the Fed would do what it takes to keep the expansion going, things right now look very similar to the relationship that the Fed and the markets had back in the 1990s. That’s the era of the so-called “Greenspan put,” slang for the market treating the Fed like a protective "put” option. At that time, if stocks fell too far, people were confident that then-Fed Chair Alan Greenspan would step in and lower rates to ease the pain.

One possible metric that makes 2019 different from 1995 is the occupant of the Oval Office. The president has publicly made it very clear he wants rate cuts, and blames the Fed for the economy’s failure to grow faster. The Fed, however, is an independent body, and Powell might feel pressure not to look like he’s just doing the president’s bidding.

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