Crossing Wall Street Review – March 16, 2018
By Eddy Elfenbein, editor of Crossing Wall Street and portfolio manager of the AdvisorShares Focused Equity ETF (Ticker: CWS)
“Individuals who cannot master their emotions are ill-suited to profit from the investment process.” – Benjamin Graham
In recent issues, I’ve struck a cautious note to investors. After the brief correction of a few weeks ago, the market rebounded very quickly. Perhaps too quickly.
I still think there’s danger out there. The S&P 500 has now fallen for four days in a row. That’s hardly a disaster, but I’m noticing a few troubling trends just below the surface. I’ll explain more in a bit.
The economic news continues to be mostly positive. We got a very good jobs report last Friday. This week’s inflation report was quite tame, which is reassuring after the surprise from last month.
I believe the big issue ahead is next week’s Fed meeting. The consensus is that the Fed will raise interest rates again. This would be the sixth rate hike of this cycle. But what comes next? That’s not so clear. I’ll lay out what this may mean for us, but first, let’s look at some of the cracks showing up in the bull market’s foundation.
Tech Has Dominated This Market and It Likely Can’t Last
I have to be up front. This is going to be a rather slim issue because, well…there’s not much going on in the market right now. But that could change very soon.
What has me concerned recently is the divergence between growth stocks and value stocks. The expected relationship is that growth leads value during a bull market, and value grabs the upper hand during a bear market. This time, growth has been giving value a super-atomic wedgie almost nonstop since the middle of 2007.
Value shined briefly in late 2016, after the election. But since the beginning of 2017, growth has been tearing up value. We see this effect in a few other areas. For example, while the S&P 500 is still well below its all-time high from January, the NASDAQ Composite recently powered its way to a seven-day win streak and struck a few new all-time highs.
When we look at classic safe-haven sectors like utilities, REITs and consumer staples, they’ve been left behind. Tech has done much of the heavy lifting for this market. Excluding a few high-profile stocks, the overall rally hasn’t been as impressive as it appears.
I don’t see how this trend can’t last. I don’t know when it will end, but I believe we’re closer to the end than to the beginning. I’m not predicting a crash or market blowup, but I do think we may soon see a change in market leadership.
About technology, I was also struck by two key news stories this week. The first is that the government blocked Broadcom’s attempt to buy Qualcomm. Let’s skip over the debate over whether it made business sense or if it’s the right government policy. The fact is they did it, and this is a big change. Twenty years ago, this kind of merger would have barely raised an eyebrow. It appears those days are gone.
The other news was that President Trump is planning to impose tariffs on up to $60 billion of Chinese imports. I’m not sure how firm the administration is on these plans. I know some people think this is the president’s “opening bid” in an effort to gain concessions later on.
I highlight these stories because I think they quietly signal the end of the post-war consensus on economic issues. For over 25 years, the global economy has moved toward free trade and relaxed regulations. Sure, there have been bumps and bruises along the way, but the free-market orthodoxy held the higher ground. These two events of this week may show that the old conventional wisdom no longer holds.
Preview of Next Week’s Fed Meeting
The Federal Reserve meets again next week. This will be the first meeting with Jay Powell as chairman. The central bank is expected to raise interest rates again. However, what comes next is the big question.
Powell will hold a post-meeting press conference, and the Fed will release updated economic projections. This is what I’m most interested in. In previous projections, the Fed has said it will raise interest rates three times this year. Wall Street seems to buy that. However, there’s a growing belief that they may raise rates a fourth time before the end of the year. That’s quite extraordinary.
Personally, I think the chances of four hikes are remote, but the futures markets currently put the odds at 33%. Seven months ago, the odds were at 0.05%. There are a few factors driving this thesis. The first is that inflation might heat up. There was some concern that the inflation report for January might come in hot. Fortunately, this week’s CPI report showed that inflation was much more subdued in February. I still don’t think inflation is an issue.
There’s also a chance that the economy could be revising up, and that may require elevated rates. It’s possible, but I don’t see the hard evidence just yet. I should note that last Friday’s jobs report (+313,000) was quite good.
There’s also a concern that the budget deficits are unusually high for this point in the cycle. That’s certainly true, but foreign investors seem quite happy to finance our spending. I had a little concern this week when investors weren’t particularly enthusiastic about the recent Treasury auctions. In the bond market, they like to watch the “bid to cover ratio.” That’s simply how much interest there is in the Treasury auction. This week’s auction had some of the weakest ratios in years.
I think of this as an early test of the Trump administration’s fiscal policy. If China, Japan and other countries still gobble up our bonds, then it’s no problem. If not, that’s going to mean higher interest rates. In turn, that means tougher competition for the stock market. I don’t see a major issue now, but there’s a chance it could become one down the road.
That’s all for now. I think the big news next week will be the Federal Reserve meeting. This will be a two-day affair (Tuesday and Wednesday). Also on Wednesday, we’ll get the latest report on existing-home sales. Then on Friday, the government reports on durable goods. Be sure to keep checking the blog for daily updates. I’ll have more market analysis for you in the next issue of CWS Market Review!