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Monthly Market Update – July 2019

June 28, 2019

A terrific month of June for investors came even as economic fundamentals have moved into palpable decline. Let’s discuss.

When I suggested a month ago that stocks in June might produce a ‘small recovery bounce…though it could be from lower levels’ (after the 6% or so drop in May), I had no idea that it would prove to be so abruptly powerful. As Wall Street opens for business on this last trading day on the month, a fully diversified equity portfolio has jumped 5.5%, bringing it within just over 1% from the 2019 peak set on April 30, and it was powered by the largest of the large U.S. stocks. The S&P 500 itself set an all-time closing high of 2951 on June 20 (although still just shy of the 10/3/18 intra-day high of 2970), with super-caps Microsoft, Apple, Facebook and Amazon up well in excess of the averages.

Today also concludes a very successful second calendar quarter and also the best first half for stocks since 1998, with the S&P 500 up more than 4% and 18%, respectively. Hear, Hear!!

A positive month for trade and interest rates

Again we have apparent progress (an arguable term, especially for the latter) on two major fronts – trade and interest rates – (which are the catalysts to thank for the massive upside reversal). Perhaps overly stung by the severe negative market reaction in May to the overt back-tracking from making any kind of trade deal, both Washington and Beijing announced they were keeping significant dialog open, perhaps to culminate with at least an ‘agree-to-agree-eventually’ at the Trump-Xi mini-summit this weekend at the G-20 in Osaka, Japan. Of course, whether this actually results in anything in the near (or even distant) future remains to be seen. For June on the trade front, hope was designed to spring eternal.

Perhaps stung by that same May market reaction to the then-negative trade news-flow, the Federal Reserve basically announced it would race to the rescue of the economy (and the markets!) if indeed those trade issues were to actually curtail economic activity. No, it didn’t cut rates at the mid-June FOMC (Federal Open Market Committee) meeting, but its prior and subsequent rhetoric has led the financial markets to price in a virtual 100% certainty that it will do so at the end of July. The yield on 10-year U.S. Treasury bonds crashed below 2.00% (now since recovered to 2.02%), still ‘inverted’ to that of the 3-month T-bill. Setting completely aside the potential negative implications of such low market-based rates, though, traders in true Pavlovian form – when offered interest rate cuts on a silver platter – roared back into stocks.

Economic trends aren’t looking good

However, as we end the merry month of June, herein lies the rub. At the broad fundamental economic level, the news just isn’t good. The all-important monthly jobs data reported by the Labor Department ‘way back’ on June 7 was a massive disappointment. Mid-month manufacturing surveys across the country were universally showing a slowdown, most especially to include employment and new orders. Consumer-oriented data has generally hung in there, a little better here and a little worse there, but these notoriously operate with a bit of a lag to major economic trends. Over the very short-term they can be skewed by gasoline and stock prices (via the wealth effect), both of which were favorable for consumers in the first half of June, but even the well-known Conference Board’s consumer confidence index reported on June 25 had dropped to its lowest level since September 2017.

Plus, our own economic tea-leaves have nothing on those that starkly illustrate the economic downshift that has already occurred across the rest of the globe. An EU-wide confidence survey has dropped back to 2016 levels. In response, most every central bank (the overseas versions of our Federal Reserve) has moved into renewed monetary accommodation, basically flooding their respective banking systems with money. To me, this was the real story of June. More below.

June’s upside = purely trader-based

Although strong on the surface, the internals of Wall Street’s rally still doesn’t resonate with me. At the highest point on June 19, all but 20-25 of the S&P 500 stocks were positive for June. For a month with generally negative-biased incoming economic data, this just doesn’t make sense. For a true fundamentally-based rally to be real and sustainable, there should at some point be some separation of the wheat from the chaff. For June, there really wasn’t.

This tells me, actually screams at me, that June’s upside has been purely trader-based. Wall Street indeed entered the month ‘short’* and the policy-maker revisionism on trade and rates initially caused a ‘short-covering’ rally. Although I’ve seen no data that fully supports this, I strongly suspect the trader community has now gone just as ‘long’ as it was ‘short’ a month ago.

This is where what I believe the real story of June comes in – that new flood of money. It’s a truism that capital will always flow to its highest point of perceived return. If the economy doesn’t care about it, which it won’t when activity is in a downshift mode, the markets usually will. If given any reason, any spark to light the fire, traders will jump all over it. The combined renewed June optimism on trade/rates proved more than sufficient.

As with any purely liquidity-driven rally, the impact is felt across all asset classes, with the relative impact magnified as the size of the aggregate asset class decreases. So it was no surprise from this point of view that the rally in bond prices was dwarfed by the rally in stocks which itself was dwarfed by the rally in commodities.

Of course, liquidity-driven markets can run only as far as the newly created liquidity will allow...or if the catalysts remain in place. So two things can go wrong. First, the traders can exhaust the available supply of new capital. Or that renewed optimism is reversed in some form or fashion.

Gold and bitcoin

Let’s talk about gold and bitcoin in June. An ounce of gold roared thru $1300 and then $1400, reaching a six-year high. I’ll give some intellectual credence to the move in gold as I believe that as a hard asset it does offer some degree of safe-haven when global economic and geo-political uncertainty rises. (Did I hear somebody say Brexit or Iran or Venezuela or any of the other half-dozen such issues out there?!). So though I’m not advocating any allocation change to gold as an investment asset, I’m quite sanguine about its move up.

I’m not so good, however, with the move in bitcoin, which at one point was up nearly 50% in June alone, up to nearly $14K. This in my opinion ranks as just about the most marginal of financial assets with little-to-zero redeeming economic value and therefore remains a total speculation and for traders only. Yes, the final ‘whoosh’ came after Facebook announced the intended creation of its own form of crypto-currency, to be called the Libra. Since the Libra is to be backed by real money, thereby giving it true value, any intellectual connection to bitcoin and its fellow cryptos is purely imaginary. Bitcoin’s rally has been a total and complete liquidity move, reversible at a moment’s notice, and, in fact, bitcoin has fallen back well below $12K.

As an aside, since Wall Street has a very high opinion of itself and will never admit to being so affected by anything that is not fundamentally driven and intellectually explainable, liquidity-sparked moves often spur the creation of new forms of logic to justify market action. My current favorite is that the use and threat of significant tariffs actually extends the economic cycle because it prevents the build-up of economic excesses that would create an eventual recession. In fact, this might actually repeal the economic cycle altogether!!

The logic continues that the accordingly slower but completely sustainable rate of growth will eliminate any chance of inflation which will allow the Federal Reserve to cut rates even further, thereby supporting ever higher stock prices. If it were only that easy, it would have worked before, during every other instance when tariffs were initiated and then failed miserably. In my humble opinion, despite what every policy-maker and politician might vow, the economic cycle will forever remain…and those stock price trees won’t forever grow to the sky.

What’s in store for July?

Never mind the above cautions, though. With traders still pouncing on all this liquidity, Wall Street enters July full of vim and vigor with predictions of a strong second half abounding. Though I continue to be as pleased (as pleased can be) to cheer it on, I remain doing so ‘from underneath’, with a modestly lower-than-target equity weighting for client portfolios. We want enough invested in stocks to know that we are participating in whatever upside might remain in this late-stage secular bull market, and the underweight allows us the ability to be appropriately ‘philosophical’ if and when things do more than ‘go bump in the night’, as happened in Q4’18.

We get a potential real kicker before Wall Street opens for business on Monday, July 1, from whatever sense of accord, or I suppose discord, is arrived at in Japan this weekend. The monthly jobs number is due later in the week. Ten days later begins the parade of Q2 earnings reports, for which, as noted last month, the level of expectations has been steadily reduced. At month-end comes the aforementioned FOMC meeting. Plus now with the first two Democratic debates in the books, national politics and their potential economic impacts will be in even more focus.

Never a dull moment in our world, but as I said to one loyal KLR Wealth client the other day, let us do the worrying for you. It’s summer time and the living is easy! Enjoy all of it and I’ll be back to you in a month.

*being ‘short’ means to be making a negative bet on stock prices. Short-covering is the reversal of those negative bets, usually made in haste and in a rapidly-rising market environment. Being ‘long’ is generally to be over-weight stocks.

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