Published October 11, 2019

Longtime readers of this column may recall that I often write that the market climbs a wall of worry. This year has been no exception.

In spite of raucous headlines and recurring bad news, the U.S. equity market has increased 18.2 percent this year through September. European and Asian markets (the MSCI EAFE index) are up 13 percent. The U.S. real GDP annualized growth rate is at 2 percent. Consumer confidence has remained strong. Inflation is subdued.

But U.S. economic production is slowing, as is capital spending and investment. Indeed, on the first day of the new quarter, the U.S. manufacturing survey (the ISM index) came in at the lowest level since June 2009; it was the second consecutive month of contraction. While business leaders and economists blame tariff wars, President Trump took Federal Reserve Chairman Jerome Powell to the whipping post, calling the Federal Reserve Board – his appointees – “pathetic.”

Consumer spending is about 70 percent of the U.S. economy, so when the consumer is happy, the economy is strong. The U.S. consumer is important to the world economy too. Right now the consumer confidence level is strong, although weakening with the slate of bad news.

The slowdown in capital spending is becoming more apparent. The International Monetary Fund has been warning about slowing for many months. We see it in Europe and Asia, and it is coming to the U.S. The long-term bull market has people thinking about a slowdown. When enough people think the economy is slowing, it becomes a self-fulfilling prophecy.

Adding to recession worries is the long-term trade conflict between the U.S. and China. The trade conflict has extended far beyond the […]

Published September 9, 2019

Investors suffered in August from sharp moves in stock prices, as our nation’s trade dispute with China and an inverted yield curve took stocks on a wild ride.

The S&P posted 11 moves of more than 1 percent in only 22 trading sessions for August. The declines included three sessions of at least 2.6 percent as well as the worst day of the year on Aug. 5.

The CBOE Volatility Index, considered to be the best gauge of fear on Wall Street, traded as high as 24.81 in August, before pulling back to around 18.

The increasing volatility was largely due to U.S.- China trade relations and a recession signal being flashed by the bond market.

August began with President Trump tweeting that he would place an additional 10 percent tariff on $300 billion in Chinese imports starting Sept. 1. The announcement wiped out the gain of more than 1 percent on the day, and the S&P finished down 0.9 percent that day.

On Aug. 5, Trump accused China of currency manipulation, and the S&P dropped nearly 3 percent.

Trade tensions escalated when the Chinese announced new tariffs on $75 billion of U.S. products. Trump responded by ordering U.S. firms to leave China and announced higher tariffs.

Overall the market lost nearly 2 percent in August – its worst month since May, when it dropped 6.6 percent.

Energy and financial stocks were the worst performers. Technology stocks suffered too.

Don’t expect much improvement in September, which since 1950 has been the worst month for the market. According to the Stock Trader’s Almanac, the S&P suffers an average loss of 0.5 percent for the month.

The meeting of the Federal Open Market Committee in September might […]

Published August 9, 2019

With the broad stock market up 17 percent year to date, the U.S. would seem to be on strong economic footing. Job growth is robust, profit growth is good enough, unemployment is low and consumer confidence is strong. So what is so wrong that the Federal Reserve was prompted to cut interest rates? Interest rate cuts are usually reserved for a weak economy.

There are numerous reasons. The president mounted a campaign to get the Fed to cut rates, which worked. The Fed was intimidated into cutting rates, because the financial markets came to expect a cut and actually demanded it. How can a market demand anything, let alone a rate cut? Well, when the financial markets bet that interest rates will go down and rate cut expectations go up, the Fed is in the crosshairs. The president’s demand clearly influenced the Fed.

Why did the president want a rate cut? The short answer is that it was good for his reelection prospects. The president has enjoyed the benefit of a strong economy, but with his favorability numbers still weak, he wanted some insurance.

Adding fuel to the fire, the president’s tariff wars are taking their toll. He promised that trade wars are “easy to win,” but they are proving to be anything but. Instead of working through existing trade agreements, the president opted to tear them up, bypass our trade allies and go head to head with China.

The president found the Chinese intransigent. That should not be a surprise to anyone with even the slightest knowledge of China. After all, China has a culture built over thousands of years as well as a long history […]

Published July 8, 2019 

U.S. equities markets streaked to new highs in the first half of 2019, in spite of a sharp downturn in May. The S&P index for the first half of the year jumped 18 percent. Before we become too smug, however, the Chinese Shanghai index and the Russian index were up over 20 percent; even emerging market Egypt, which I just visited, was up.

Best performing sectors in the U.S. were technology and consumer discretionary, with health care bringing up the rear. The prospects for the rest of the year are less sanguine.  The expansion is historically long, and the effects of the “tax cut” are wearing off.

Attention now shifts to Federal Reserve interest rate decisions. With Fed futures now forecasting a 100 percent chance of an interest rate cut, the only question appears to be whether it will be 25 basis points or 50 basis points. There is very little discussion, let alone support for no rate cut. The wisdom of a rate cut is questionable, given that the economy is very strong (though slowing). With 7 million jobs available and only 6 million people to fill them, it is difficult to see the economic need for a cut. It would be an “insurance cut,” because there are signs that the U.S. and global economies are flagging. So there is political pressure to “goose” the economy. With these rate cuts, the Fed would have fewer tools at its disposal to cut rates when they are actually needed.

The actual cause of the slowing global economy is tariffs. The on-again, off-again tariff war has created uncertainty. Investors hate uncertainty. Companies have postponed capital expenditures, because they are uncertain […]

Published May 13, 2019

The market began the year with its best start since 1998. After the jarring fourth quarter of 2018, the broad market powered its way to all-time highs. By the end of April, the market had gained 25 percent from its 2018 Q4 bear market low and 545 percent from the March 2009 financial crisis lows.

Gross domestic product (GDP) growth is running at about 3 percent – a significant improvement from the 2 percent of just a year ago.

April saw 265,000 new jobs added; that is a very strong number. Unemployment reached lows not seen since December 1969. There are a record 7.5 million job openings in the U.S.

Inflation remains low, but so do wage gains. The Federal Reserve, under pressure from President Trump to cut interest rates, declined to do so; nevertheless, the market priced in one rate cut for the rest of the year anyway.

The outlook for interest rates remains somewhat cloudy because of White House pressure, but Federal Reserve Chairman Jerome Powell will likely keep to the Fed’s established course, at least until the end of the year. That is, of course, unless Powell is forced out of his job. So far, efforts to restock the Fed with Trump supporters have failed, largely because of the lack of support for the potential replacements. The result is that interest rates will likely remain where they are until at least the end of 2019, even though a strong argument could be made to raise and “normalize” rates. Sooner or later the markets will need support from the Fed, so the Fed needs some “dry powder.”

In the face of many obstacles, such as China-U.S. […]

Published April 8, 2019

The last quarter of 2018 was a big disappointment to investors. Beginning in the autumn of the year, the market dropped 18.9%, reaching a bottom on Dec. 24. While not panicking, investors were certainly shaken.

The world economy, including the U.S., appeared to be slowing. To make matters worse, the Federal Reserve, sticking to its script, raised interest rates by a quarter point, extending worries about the economy. The market drop was sharp.

But, as often happens, the market surprises. The first quarter of 2019 was the best since 1998. The S&P index was up 13.1%, the Dow up 11.2% and the Nasdaq up 16.5%. Well, how do you explain such machinations?

In the fall of 2018 it became clear that the global economy was slowing. At the same time, the Federal Reserve believed it was time to raise interest rates. A bit of a back story: after a long time of historically low interest rates, some believed it was time to raise rates; the Fed subscribed to this idea. We have often written here of policy accidents. We have been worried about policy accidents. The Fed, looking at its tea leaves (and its point chart), decided that we needed to go on a rate-raising program. And raise it they did — nine times since December 2016, including three times in 2017 and four times in 2018.

But with the economy slowing, was December really a good time for another increase? President Trump, who considers himself an excellent forecaster, told the Fed not to raise rates. The Fed, which considers itself independent of political pressure, felt cornered, and to show its independence, resolved to raise rates.

They had […]

Published March 11, 2019

Brazilian private equity firm 3G Capital burst into the United States when it bought well-established food companies Burger King in 2010 and H.J. Heinz in 2013. Its method of operation included cutting costs and executing mass layoffs. 3G attracted the attention of other hedge funds and Warren Buffett’s Berkshire Hathaway. Together, 3G and Buffett bought U.S. ketchup maker Heinz.

In 2015, with Buffett’s help, Heinz acquired and merged with Kraft Foods to create the world’s fifth-largest food company. It was a classic Buffett buy: an easy-to-understand company with iconic American brands, not unlike other long-term Buffett holdings, such as Coca-Cola and Dairy Queen. 3G and Kraft Heinz next attempted to buy Unilever for $143 billion, but that deal collapsed amid concerns about a cultural clash of the two entities.

On Feb. 22, Kraft Heinz disclosed that the U.S. Securities and Exchange Commission was investigating the company’s “accounting policies, procedures and internal controls in procurement.” Kraft Heinz’s share price plunged 27 percent that day; the firm wrote down $15 billion in the value of its Kraft food lines, including Kraft macaroni and cheese, Oscar Mayer hot dogs and other waning brands. The firm also slashed its dividend. The write-down called into question 3G’s management style.

3G had underinvested in its brands to maximize current earnings at the expense of growth. Consumers have demonstrated a declining interest in its legacy food brands such as Velveeta cheese, Kool-Aid and Jell-O and a growing interest in natural and organic ingredients and products. Furthermore, consumers’ buying habits have changed, with private labels such as Costco’s trusted Kirkland Signature putting additional pressure on national brands to maintain position on grocery shelves.

3G’s slash-and-burn […]

Published February 11, 2019

The U.S. has just completed the longest government shutdown in its history. The shutdown came to an end when President Trump backed down from his demand that the government fund his oft promised wall on the southern border of the U.S.

Trump’s “big, beautiful wall” was to be paid for by Mexico. When that didn’t happen, he demanded that the U.S. government pay for the wall. The price tag is estimated at $5.7 billion. When the House of Representatives refused the funding, the president allowed “non-essential” government services not to be funded – an act that he said he was “proud to own.”

After the economy teetered on the brink, the shutdown ended. Government services resumed. Employees, who had not been paid for a month, are in the process of catching up on the work not done during the stoppage. Among the many consequences, the Federal Reserve had to make interest rate decisions at its January meeting without full details of the economy. The Fed wisely decided not to change rates.

Now negotiations are going on within the government as to whether or not the government will pay for the wall. Three weeks were allocated to make that decision. President Trump, who advertised himself as a champion dealmaker, has so far found a deal elusive. He now says that he does not believe current negotiations will yield a solution that he can accept. Since he is apparently playing no role in the negotiations, it is likely that he will not approve any proposal. The question then arises: What will happen next? The president’s State of the Union speech provided no answers.

The fallout from this recent shutdown […]

Published January 14, 2019

Over the course of the past year, I have written often of the risk of policy accidents. Since September, two significant policy accidents have created havoc in the financial markets.

First and foremost is the tariff war. Although initiated earlier, the tariff war came home to roost in the fourth quarter of 2018, when tariffs began to have their full impact. Once billed “easy to win” by the president, the tariff war is proving anything but easy. As the impact of the trade war on the global economy became visible and economies began to slow, the prices of equities and commodities fell in concert. Money began to flow from these assets, and markets tumbled.

Then the Federal Reserve made good on its promise to raise interest rates. Chairman Powell promised to raise rates until the Fed charts showed that rates were in the “right place.”

And so, beginning in early September, equity markets tumbled into bear market territory, down about 20 percent. The markets went from optimism to pessimism in a matter of weeks. The yield curve suggested a recession was in the offing. Having predicted 13 recessions – and eight happening – the yield curve frightened investors. Retail investors bailed out in fear. Institutional investors, by and large, held their ground. Volatility went to extremes, with the Dow stocks plummeting nearly 800 points one day and jumping 1,000 points another day.

Fundamentals remained strong, but with the cloud of dubious leadership, confidence was shaken. With the “full faith and credit of the United States” in doubt, investors ran for cover.

Added to these factors were Brexit, riots in the streets of France, Italian budget problems and a […]

Published December 10, 2018

I have frequently discussed the danger of policy mistakes in this column. This year has seen a plethora of policy mistakes, and they are now coming home to roost. In spite of a strong economy, with growing GDP, full employment and record consumer confidence, the U.S. equity market suffered big losses in October. Since the market normally looks ahead six to nine months, what did it see?

Not to be outdone, U.S credit markets have suffered their worst year since 2008, as investors shed corporate debt. What brought us to this point? Can the mistakes be rectified?

The first policy mistake was by the Federal Reserve. After record low interest rates for a very long time, the Federal Reserve has been on a rate hike trajectory. Ever cautious, Janet Yellen was on a very slow, deliberate, rate-rising schedule. The market did not question the need to raise rates. However, President Trump decided to replace Yellen, reportedly because she was too short at five feet, two inches.

The president handpicked Jerome Powell as his chairman. Powell had a different idea on rate increases; he wanted more and faster increases. The market absorbed this news at first, but when Powell announced in September that rates were not near normal – i.e., not high enough, the market broke. The S&P dropped 6.8 percent for the month. Trump, who has extremely high disapproval ratings, has been able to count on a strong economy to buoy his presidency. Now, with the economy threatened, the president eviscerated his own appointee.

The Federal Reserve has been considered independent since its inception over 100 years ago. Whether Powell listened to his president or to the […]