December 18, 2018

Stocks opened higher this morning (Dow 243 pts; SPX .5%) in an attempt to recover from yesterday’s rout. A number of market sectors are up about 1%: industrials, real estate, materials, communications services and consumer discretionary. Energy stocks are down following oil prices. WTI crude oil fell to a 15-month low after a report that global oil production is rising. European stock markets closed down about .7% and Asian markets were down overnight. China’s Shanghai Composite Index is down 22% so far this year in local currency terms (or about 26% in dollar terms). Commodities are mixed in early trading. As mentioned, WTI crude oil is down around $47/barrel (down 36% since early October. Consensus Wall Street opinion is that global oil demand is just fine, but supply is temporarily too high. As I’ve mentioned before, there is a lot of room for traders and governments to manipulate oil prices. Bonds are mixed in early trading. Treasury bonds are rising but junk bonds are falling in price. The 5-year and 10-year Treasury note yields are back down to 2.67% and 2.83%. Remember last summer when traders were freaking out over rising interest rates? They feared higher mortgage & auto loan rates and worried incessantly that the Federal Reserve would have to keep hiking rates to keep pace. Well, those concerns seem in the distant past now. We’re all wondering what the bond market’s massive volatility is trying to tell us.

Yesterday, in contrast to the panicky reporting of markets on CNBC, the S&P 500 Index simply retested its February correction intraday low of 2,535, and then closed slightly higher at 2,545. That didn’t make anyone excited about stocks again, but from a technical analysis perspective, it’s encouraging. It makes sense. When the stock market is re-rating (i.e. getting cheaper) it often looks for support at prior correction lows. So traders are now watching closely to see if the retest is proven successful.

In a way, yesterday’s and today’s trading sessions don’t mean a thing. That’s because the Federal Reserve begins its monthly policy meeting today. Their decision will come tomorrow. Capital markets are clearly pleading with the Fed to forgo a rate hike, and instead acknowledge rising risks to the economy. It’s no secret that the economy is slowing from 3%+ growth, to about 2.5%. All else equal, that’s not a big deal. Most economists figure 3% is too high to be sustainable anyway. But all else is not equal. Rising geopolitical risks (i.e. trade war) could threaten the economic cycle. We really need the Fed to acknowledge this risk and pause its monetary tightening for a while.

Of course, the Fed is between a rock and a hard place. They’ve kept interest rates ultra-low for a long time in order to boost the economy. Now they need to bring rates back to a more normal level in anticipation of the next economic recession, when they’ll need to lower them again. This is where we get the time-honored analogy about bullets in the gun. The Fed needs to reload interest rates so that they have some ammunition the next time we’re in a crisis. It’s as simple as that. Normally, the Fed’s official job description—promote full employment, maintain stable & moderate inflation—is what drives it to either raise or lower interest rates. But these days, we already have full employment and stable inflation covered. So the only other reason the Fed might continue pushing up rates, aside of what I mentioned above, is that their economic outlook may predict significantly higher inflation than we’re seeing now. And I must say with certainty that the investor community would vehemently disagree. Hence Jim Cramer’s comment that over the long-term, stocks are still the “greatest wealth creator of all time,” but in the short-term, “we are in the hands of the Fed.”

US housing starts surprised to the upside in November. The total volume of new homes beginning construction rose to an annualized rate of 1.25 million units. The volume of new building permits also surprised to the upside. Unfortunately, most of the unexpected strength was driven by multi-family developments. Most housing market analysts say the multi-family segment has been saturated for quite a while. So this probably doesn’t signal a strong rebound in the housing market. The simple fact is that affordability reached a breaking point and home-buyers are more cautious. This doesn’t mean a housing crash is on the way. To the contrary, a tight labor market and otherwise pretty strong economy should prevent that. But you can’t have home prices rising 5-7% per year forever.


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