Jackson Hole, Wyo., the site of last week’s Federal Reserve Bank Economic Symposium.
Powell delivers perfectly
Dalton — People expect too much. Last week financial prognosticators focused on the Fed’s annual Jackson Hole Economic Symposium (Friday, Aug. 23) and the headline speech delivered by Fed Chairman Jerome Powell. They expected Powell to talk about where the Fed was going to go on interest rate policy. That, however, was not on the agenda. That’s not a figure of speech. I mean it literally was not on the agenda for this annual meeting. It never is.
This annual meeting and subsequent speech have traditionally been to discuss broad monetary and economic themes rather than to send policy signals. Yet investors were clamoring to see what hints Powell might give regarding the Fed’s next moves as they seemed to expect the Fed to take action at this non-policy meeting. Powell faced a significant challenge in defining an axiom about when to cut rates, without linking it to what’s happening today. Powell stayed on agenda perfectly while still satisfying those who were hoping for something more, namely that he’d act as appropriate to sustain the U.S. economic expansion.
Powell offered very little in terms of direct guidance on where he thinks interest rates should go, but he did leave a little room for interpretation. Here are the bullet points of what he did say:
- There is no “rulebook” on how to handle a trade war, pointing out that, instead, monetary policy is a proven tool to support consumer spending, business investment and public confidence.
- Powell repeated his pledge to “act as appropriate” to sustain the economic expansion.
- “The global growth outlook has been deteriorating since the middle of last year,” he said. Since just the last meeting of the Federal Reserve Open Market Committee (the FOMC are the members of the Fed who vote on setting interest rate policy) in July, Powell stated there has been further global economic deterioration, specifically citing the Hong Kong protests, continued economic and political turmoil in Italy, the possibility of a hard Brexit, and a lot of talk about trade.
- Regarding the Fed’s dual mandate of full employment and price stability, Powell said the “economy is close to both goals” and that the U.S. economy has “continued to perform well overall,” even while facing challenges.
- He cited 1995 and 1998 as previous periods when cuts were made as a mid-cycle adjustment as opposed to at the start of a cutting cycle. This was in the context of addressing how monetary policy was previously used, noting that the cuts then were to address low inflation and liquidity (the “breaking the buck” of a large money market fund in 1995 and the Asian financial crisis in 1998, which both affected liquidity negatively) as opposed to addressing a growth concern.
The chairman appeared to be sending a message to the White House that its trade war is pushing the U.S. toward a recession, and that the Fed may not have the tools to bail us out if that happens. Although Powell did not commit to another rate cut in September, as this was not a policy meeting, he did note that the rate cut in July, coupled with expectations for additional easing, had supported financial market conditions. Powell and the rest of the Fed recognize that if the Fed doesn’t deliver what investors anticipate, financial markets could tighten significantly. Fed fund futures had priced in an almost 90% chance for a 25-basis point rate cut at the Fed’s Sept. 18 meeting. After the chairman’s speech, the odds went up to 100%.
Enemy of the state
Some might call it speculation; I call it an educated assessment. President Trump is risking pushing the U.S. into recession with the trade war to get the Fed to cut rates, hoping the Fed will give the U.S. economy the stimulus it needs to keep growing. Whether you agree with the objective to improve trade with China or not, the tactics are dangerous. If you think that this escalation of tariffs is not getting us closer to recession, corporate CFOs are saying you’re wrong. And if you think the Fed has a playbook on how to use monetary policy to get us out of a tariff-induced recession, the Fed is saying you’re wrong.
I don’t care about your politics. This isn’t a blue or red column; it’s an is-your-money-safe-or-not column. I want to see Trump win on this one and get a trade deal that specifically protects the intellectual property rights of U.S. businesses. That protection is far overdue. But Trump is going further than that. He’s trying to get more companies to manufacture in the U.S. That’s commendable, but his tactics suck.
Some U.S. companies have made a cost-benefit analysis and decided not to outsource manufacturing to China anymore. Some of those companies have switched to other areas to manufacture, such as Vietnam. But China has a decade-plus head start with roads, ports, airports, specialized supply chains and factories with U.S.-focused safety certifications. Also, Vietnam has only a population of about 100 million, compared to 1.3 billion in China, so it’s easier for China to find employees. Similar arguments can be made for other nations, including here in the U.S. The machinery used to manufacture a lot of these specialized goods is capital intensive, and not only do you need to find workers in a tight labor market, many of those workers would need time to update their skill sets.
Moving production facilities is a process, and Trump is forcing it to be an event with these tit-for-tat tariffs. U.S. companies are trying to be part of the process, trying to utilize on-shore manufacturing. But before they can realize a long-term, on-shoring solution, they need to be involved in shorter-term negotiations as their import costs increase, causing consumers to shift preferences.
Again, not a comment on politics, or even objectives: It’s the tactics that concern me. One of those concerning tactics is the sitting president of the United States villainizing the sitting chairman of the Federal Reserve board via Twitter. After the chairman’s Jackson Hole speech, which, again, is not intended to discuss or set monetary policy, President Trump was upset that the Federal Reserve, quite frankly, did its job and did it well. Trump expected too much and was upset that he didn’t get what he wanted. On Twitter, President Trump ripped into Chairman Powell, calling him an “enemy” after he “did NOTHING” (again, I can’t overstate this: This was not a policy setting meeting).
As recently as this month, Trump called China’s President Xi a friend, at one point even saying that his “respect and friendship with President Xi is unlimited.” I am as much a Machiavelli fan as the next amateur philosopher, but I doubt that the tactic of the sitting U.S. president to now call both Xi and the chairman of the Federal Reserve enemies will prove to be one that garners quality results.
The “Chosen One”
Last week President Trump self-proclaimed himself to be “the Chosen One,” the person to confront China on its alleged malpractice of trade. I’m not one to question prophecy, but I’m not convinced this was the intended path to reach the promised land.
On Friday China announced its retaliation to President Trump’s latest tariffs, saying it’ll apply new tariffs on $75 billion of goods. The amounts range mostly from 5% to 10%, but as high as 25% on autos, and will be implemented in two batches on Sept. 1 and Dec. 15,, which are dates matching the latest rounds introduced by President Trump on China.
It didn’t take long for Trump to tweet that “our great American companies are hereby ordered to immediately start looking for an alternative to China, including bringing your companies home and making your products in the USA.”
The order President Trump is referring to is the International Emergency Economic Powers Act, created in 1977. The IEEPA has been used previously by President Trump as well as other presidents on 30 previous occasions. This law gives the president a wide range of powers. It can’t be done via tweet, but the president can declare a national emergency in response to any extraordinary threat to the U.S. so long as a substantial source of that threat is off our soil, and then issue an executive order.
I’m all for creating an environment where it makes sense for U.S. companies to elect to do what President Trump has ordered them to do, assuming their election to do so would be done in a proper manner. But to do so with any type of immediacy is an idea that is fraught with negative unintended (but obvious) consequences. Remember what I wrote about the problem of moving just some manufacturing from China to Vietnam? Global industrial supply chains are complex. A presidential order of this magnitude would shoot us right into a recession and global economies and stock markets would fall apart. I’m not alone in that opinion, as U.S. stock indices sank by more than 2% into the close as U.S. business groups denounced the statement, saying that it would jeopardize their operations. The National Retail Federation pleaded that, “it’s impossible for businesses to plan for the future in this type of environment.”
At 5 p.m. on Friday, after a day of meeting with his trade advisors, President Trump went beyond the IEEPA to more than settle the score on China’s retaliation. The White House officially announced that the $250 billion of Chinese goods recently involved with the tariff conversation will have duties raised from 25% to 30% on Oct. 1. And the new tariffs on $200 billion of goods that were to start on Sept. 1st will now be 15% instead of 10%.
U.S. manufacturing conditions continue to weaken. There are different ways to measure U.S. manufacturing; I’ll spare you the accounting details and get right to the point. The Markit Purchasing Managers’ Index (PMI) edged into contraction territory in August, moving from essentially stagnant in July. Seeing how tariffs have cut U.S. auto exports to China in half, it’s a wonder it’s not worse. The good news is that I put more stock in manufacturing index from the Institute of Supply Management (ISM), which is firmly above recession thresholds. But the decline in the Markit PMI suggests to me that the ISM may decline this month, as well, which will give the Fed more cover to cut at the Sept. 18 meeting.
Lies, damn lies and statistics
After Friday’s presidential tweet storm, and in anticipation of the White House’s retaliation announcement to China’s new tariffs, stocks got crushed. I am aware that when stock prices are down, those with bullish commentary sound like the biggest idiots. So as not sound like an idiot, I should do myself a favor and caution against further declines. But I’ll largely just shrug that off. Readers will remember that my mid-year outlook for U.S. equity indices was that although I’m expecting a recession in 2020 or 2021, I am comfortable holding stocks throughout the second half of 2019, with an expectation of nothing worse than a brief and temporary ordinary decline. I said that a 12.1% decline would be about the worst I’d expect; a drop of that magnitude in the second half was not just a possibility, but a low probability. (I grew up in the world of statistics; there is a meaningful distinction between possibilities and probabilities.)
A few weeks ago, on Aug. 5, a decline of about 6.8% was enough for me to get cash invested into stocks. I didn’t have a lot of dry power to get to work on that day, but we did take advantage of it. If you missed that opportunity, still have that cash on hand and are looking for an entry point, the recent pullback is an opportunity. It’s not an opportunity just because it went down. Like I said, you sound like a big idiot if you are bullish when stocks go down. Sometimes they go down and keep going down. Let’s eliminate the platitudes about stocks going down being a good thing for long-term investors (that doesn’t just sound stupid, it is stupid), and instead let’s consider the evidence. In the last month, there have been some big down days, flushing out the weakest of hands. That’s not good news by itself, because lower prices could ultimately be a proper reflection of deteriorating fundamental and more selling can occur. However, recent selling (i.e. a higher supply of available stocks to buy) has been met with investor demand (i.e. more buying).
While the declines on Aug. 23 and Aug. 5 were similar, the magnitude, percent of downside volume and percent of declining points were all a bit more subdued on the 23rd. This is evidence of an exhaustion of supply. What happens this week (will demand absorb the new supply?) will be meaningful, but up until now, the evidence has been bullish. Despite recent market weakness, the advance/decline line (the advance/decline, or A/D line, is a breadth indicator used to show how many stocks are participating in a stock market rally or decline) is above its rising 150-day moving average. More importantly, the A/D line confirmed the recent high in stock prices with its own new high in July, which is consistent with an enduring bull market. In the past, these conditions typically coincided with key market turning points.
I expect new market highs in the months, maybe even weeks, to come. If that happens with breadth continuing to expand, we’ll hold and probably make some more good returns. If those new highs occur as the A/D line turns down, we’ll come up with a different strategy.