Slightly Positive Monday

Monday’s trading action was what you’d expect from a market anxiously waiting for big new events to unfold later in the week. The S&P 500 was up 0.11% which 4.57 points off the March high. The S&P 500 almost crossed above that point, but there was a minor selloff at the end of the day. This technical point and the all-time high are relatively meaningless in the face of the Fed meeting on Tuesday and Wednesday and the Trump-Kim meeting which will occur at 9AM on Tuesday in Singapore. That is 9PM Monday night in New York. As of the writing of this post, it looks like the meeting will occur. I’m not sure when it will end, but Kim is planning to leave at 2PM. That means the result of the meeting will be known before the stock market opens Tuesday. Unless it ends in disaster, I expect a modest exhale from investors, which would be a small rally.

Dollar & Treasury Action

The dollar index was up 4 cents to $93.61. If the North Korean summit goes well, I expect the dollar to sell off and if it fails then I expect the dollar to rally. That’s against natural instincts if you think about what is good for America, but it makes sense if you look at the dollar as a risk off trade. The 2 year treasury yield was up 2.25 basis points in anticipation of the Fed rate hike on Wednesday. The 10 year treasury yield was basically flat which means the curve flattened as you can see in the chart below. I don’t think the North Korean summit will affect the curve, but treasuries will rally if it goes awry, since that’s the risk off trade. The curve is the flattest of this expansion just as the Fed is meeting which means it will be discussed heavily. The CPI reading on Tuesday will also affect markets. The consensus estimate is for core CPI to be up 2.2% year over year.

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Bear Market Checklist

I love to review checklists because they quickly show a complete overview of a macro thesis on the markets. I have generally disagreed with bear market checklists which show stocks will plummet soon. That has been the correct analysis for the past 2 years as stocks have rallied. Every checklist has new indicators to review. The table below shows one from Morgan Stanley.

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The first bullet is rising PMIs transitioning to falling PMIs. America isn’t one of the countries with falling PMIs. In fact, as you can see in the chart below, global growth isn’t that bad. The GDP weighted growth is still steady. The blue bars show the problem is a few countries aren’t doing well as the dispersion among growth rates in global nations has increased. There’s no more global synchronized growth as many countries such as Brazil, Turkey, Japan, and Europe are seeing weakness. There’s also the economic collapse in Venezuela and the geopolitical tensions in Iran and North Korea. In summary, there are some countries which are seeking weakness, but not enough to say global PMIs are falling. If America contracted, then I’d agree with this point.

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The second point is sideways inflation turning into increasing inflation. The global inflation rate has been increasing because of the commodities rally, particularly oil. Core inflation in Europe is still very low. It’s only 1.1%. It has been below 1.2% since 2013. It has been below 2% since 2003. In America, it’s still too early to claim this bout of inflation is anything different from previous ones in this expansion. To be clear, I’m referring to core PCE and core CPI. Core PCE has peaked at higher points than it’s at now on two previous occasions in this expansion.

Everyone assumes that because we are late in the cycle, the inflation needs to pick up. That thought process was proven wrong in 2017 as inflation fell. This time looks promising because the labor market is tighter, hourly earnings growth is faster, and GDP growth could be faster especially in Q2. However, it’s still far from being a problem, so even an acceleration wouldn’t cause me to be bearish. Even if the core CPI beats on Tuesday and comes in at 2.3%, that still would only match the cycle peak. In summary, I’m watching inflation closely, but I’m not worried about it. You expect inflation to go up late in the cycle. It needs to beat those expectations to get me worried.

I also disagree with the 3rd point for reasons I will be reviewing after the Fed’s rate hike decision. In the Fed’s Minutes, it mentioned it won’t start accelerating rate hikes if inflation is slightly above its target. That completely destroys this third bullet because it implies that once inflation gets to the Fed’s target, something bad will happen. Most market participants can see inflation increasing modestly this year, so it wouldn’t be shocking. There needs to be a change which boosts inflation more than expected to cause the Fed to start hiking rates at a quicker clip.

The final point I’ll review in this post is the 4th bullet which shows there’s no longer a fiscal policy catalyst to cause the market to go up. Bearish investors who claimed rate hikes and the end of QE would end the bull market followed along this narrative that the market needs support to go up. So far, the balance sheet reduction and rate hikes haven’t ended this bull market.

With the tax cuts, we’re still in the beginning stages of seeing their impact on the economy. The excitement about them which led to amazing returns in 2017 won’t be repeated. Now we’re left with a secular tailwind for the economy and higher profit margins. That doesn’t sound like a bad situation at all. If the tax cuts have a better than expected impact on the economy, this can act as a catalyst to move stocks up. As you can see, I’ve countered the first 4 points. I’ll review the others in a follow up article.