by Blaine Rollins, CFA, 361 Capital
Cooler air in Colorado brought us a combination of golden aspen trees and white dusted peaks this weekend. As the colors have changed in our mountains, they have also changed on most market price screens from green to red. The hot U.S. economy and inflationary picture has suddenly increased the hawkishness at the Fed. Chairman Powell’s phrase that paid last week: “We’re a long way from neutral Fed Funds at this point, probably.” As a result of this more strongly conveyed mood, interest rates continued to jump higher. Probably, a bit too quickly for most investors’ comfort which caused some sharp negative price reactions across the risk spectrum. Go look at housing stocks which have fallen for 13 days in a row as investors worry over higher mortgage rates’ impact on new home sales, not to mention the higher cost to finance raw land inventory and working capital. Risk-free rates are no longer zero. They actually have a yield today between 2.2% and 3.4% depending on the maturity. If you are a borrower, you now have a cost of capital to jump over. If you are an investor, you actually have a safe place to make a few percent rather than take risk.
Earnings will begin to be reported this week. As always, the big banks will start us off. Investors will be looking at loan growth (in the face of rising rates) and net interest margins (in the face of a flatter yield curve). We will also be hunting for the first signs of credit weakness. And most important, we will be looking at the market’s reaction to the all-important bank stock group as they report their numbers. In July, the market rewarded the group with immediate thumps on the head. Will it be different this time? As other companies begin to report their third quarter earnings, we will be watching to see if companies can manage inflating costs, global trade impacts and rising interest rates. Just today, PPG raised all prices 10% on their paints and coatings to fight across-the-board price increases. Last week, Amazon moved its minimum wage to $15/hr to better find and keep its employees. Expect price and margin discussions to run long on the quarterly conference calls.
So, enjoy the cooler temperatures outside as you grab a coat and gloves in the morning. You might also consider packing something warm for your stock portfolio because this earnings period will be much more interesting than the last one.
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Federal Reserve Chairman Jerome Powell did a Q&A today. I was not surprised that he maintained the continued “gradual rate hike” mantra. I was surprised when he said “we’re a long way from neutral, probably.” That seemed like it was a bit of a slip. And a hawkish one at that. What seems remarkable to me is that I keep hearing a dovish interpretation of the Fed’s recent disavowal of r-star and the related demise of forward guidance. But what Powell let slip is that he clearly still has an estimate of neutral and we are nowhere near it. That’s hawkish.
Powell also added that “we may go past neutral.” In this sense, he is arguably a bit more dovish than colleagues such as Chicago Federal Reserve President Charles Evans, who reiterated toady his expectation that rates turn restrictive. Still, I see Powell as edging toward admitting what the forecasts reveal. Remember, you don’t have r-star as a guide anymore, but you still have the rate forecasts. You might say that there is a wide variation in the rate forecasts. But it looks like there is a common element – no matter where a central banker thinks neutral is, the majority if not all (not counting St. Louis Federal Reserve President James Bullard), expect rates will climb above their estimate of neutral. In other words, they all see policy as becoming restrictive.
Take the forecasts seriously. Handicap the data against the forecasts. Right now, the forecasts tell a hawkish story, especially if you let go of the r-star anchor. And the data doesn’t give reason to think otherwise.
But as J.P. Morgan knows, bad news can make oversold conditions even cheaper…
The likelihood of a “full-blown trade war” next year between the world’s two largest economies made JPMorgan Chase & Co. the latest brokerage to drop its bullish call on Chinese stocks.
The trade conflict will only escalate as the U.S. maxes out tariffs on Chinese imports, the dollar strengthens and the yuan weakens further, JPMorgan strategists including Pedro Martins Junior, Rajiv Batra and Sanaya Tavaria wrote in a report, lowering their recommendation on China to neutral from overweight…
“A full-blown trade war becomes our new base case scenario for 2019,” the strategists wrote in a note dated Wednesday. “There is no clear sign of mitigating confrontation between China and the U.S. in the near term.”