The Fed, The Economy, and The Donald

The FOMC made the unanimous decision to leave the target interest rate unchanged. This was no surprise. The market had been pricing this in, not just for the July meeting, but for the next two meetings (September and November) as well. Unless we start to see some wage inflation, the market is pricing a rate hike in September at 0% probability and the December meeting is given only a 50% chance of a hike by the CME Group FedWatch Tool.

The Fed will find it impossible to raise rates out-rite until inflation starts to head closer to the 2% target, but it can still raise rates tangently by starting to normalize its balance sheet “relatively soon”, which historically means “at the next meeting”. If the Fed starts to lighten its “book” in September by selling its long-dated debt holdings, then the 10-year and 30-year Treasuries should experience a drop in price and, therefore, a rise in rates. Despite this, long-rates rose only slightly this week.

The earnings reports this week continued to display healthy growth. According to FactSet, the blended earnings growth rate stood at 7.2% at the start of the week, and 9.1% by the end of the week. Despite the strong results, there was a tendency to sell the news causing the S&P 500 to finish unchanged for the week.

Economic data showed real GDP increasing by 2.6% which was the second-highest rate over the last eight quarters. However, this did not excite the market because the first quarter growth rate was revised down to 1.2% making the average a less-than-impressive 1.9%. This will keep the Fed watchful of the economy as it tries to normalize rates going forward. Hopefully, it will also increase the sense of urgency in Congress to pass a tax deal that allows for expansive fiscal policy. The Trump-trade fizzled out months ago, leaving earnings to do the heavy lifting in the stock market. The market needs to believe that as monetary policy is tightened, fiscal policy is loosened, but only Congress can turn the belief into a reality.

Unfortunately, Congress is proving that the Donald is a lame-duck President after only six months on the job, which must be some kind of record. Despite having a majority in both houses, nothing of economic value has been accomplished since the reality-TV personality moved into the White House. The Fed cannot push the economy much higher without the government providing the fiscal muscle.


Equity

The AAII sentiment survey reported a 1.0% and 1.5% drop in bullish and bearish sentiment respectively. These drops were both added to the neutral camp making the bull:neutral+bear ratio 34.5:64.5 which is still not overly bearish; major market tops tend to occur when bullish sentiment is greater than 50%.

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The put-to-call ratio is in a neutral stance which is not telling us anything about future probabilities (chart below).

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Fundamentally, the business cycle continues to be in a growth phase as demonstrated by the GAAP earnings (chart below). This points to a continuation of the bull market.

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The European markets have been affected by the strength in the Euro and the corresponding weakness in the dollar (chart below).

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Tesla previewed the new model 3 on Friday and gave Motor Trend an exclusive test drive. You can read the gushing review here. TSLA has checked back to the $333 support level, and if it closes below this level, we will close our call option position before the August 2 earnings report (chart below).

Gold

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The dollar’s weakness and the market’s belief that the Fed will not normalize rates, have driven gold higher, but we still do not see this as the start of a new bull market in gold. Using TIP as a proxy for inflation, we see that inflation has not yet broken its down-trend line (chart below), and since the Fed is itching to raise rates, inflation is unlikely to get out of hand.

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Forty years of private equity trading, and still learning.