Crossing Wall Street Review – May 19, 2017
By Eddy Elfenbein, editor of Crossing Wall Street and portfolio manager of the AdvisorShares Focused Equity ETF (NYSE Arca: CWS)
Wall Street’s deep sleep came to an end this week. The S&P 500 had a run of 16 straight days in which it never traded outside a band that was a little more than 1% wide. Then on Wednesday, the index suddenly dropped 1.8% for its biggest plunge all year.
Of course, that drop was from an all-time high close, so we can hardly say that there’s been a lot of pain on Wall Street. The major indexes are still having a very good year, and it’s only May. The move was such a shock since everything had, until then, been so complacent.
But here’s the key, Wednesday’s drop wasn’t spread out evenly. Many of the stocks that characterized the Trump Rally, like the big banks, fell the most. At the other end, defensive stocks fell the least. Some even rose a tad.
What does this all mean? There’s been a lot of talk that this is Wall Street’s verdict on President Trump. I don’t buy that at all. What’s really going on is that Wall Street is suddenly getting cold feet about another Fed rate hike. I’ve been warning that a rate increase next month would be a mistake. Some folks, apparently, are coming around to my side. I’ll have more on that in a bit.
In recent issues, I’ve said that it would be a mistake for the Federal Reserve to raise interest rates next month. The economy, sadly, just isn’t strong enough. Since I’m not a member of the Federal Open Market Committee, my views on the matter don’t count for much. But this week, the world may have shifted in my direction.
According to the latest futures prices, the market is placing 73.8% odds on a rate increase in June. That’s high, but it was even higher not too long ago. That’s why Wednesday’s selloff caught my attention. The worst performers were big banks and financial institutions. The best performers were high-dividend stocks like REITs and utilities, with some consumer cyclicals.
Whenever you see banks and dividend stocks move in opposite directions like that, you know that the market is arguing about the direction of short-term interest rates. Banks want short rates to go up. Dividend-payers want them to go down. When it’s a big drop like this, it’s almost as if the market is begging the Fed for some relief. I don’t know if they’re listening.
What makes this more interesting is that the economic news has been getting a little better recently. Still not enough to justify a rate hike, in my opinion, but we must consider all the evidence. For example, on Monday, the industrial production report was quite good. Economists had been expecting industrial production to show a 0.4% rise for April. Instead, it was up a full 1%. That’s the biggest increase in three years. Importantly, it’s for the month of April, which is in Q2.
A few weeks ago, we learned that the U.S> economy grew by a meager 0.7% for Q1. That’s pretty bad. Next week, we’ll get an update. But now we’re starting to get a few clues for what the Q2 numbers will be like. The Atlanta Fed has its GDPNow forecasting tool, which says that Q2 GDP is currently tracking at 4.1%. I have to be honest: that shocked me. I hope they’re right, but we still need to see more data.