361 Capital Market Commentary | April 1, 2019
Bond investors liked it. Stock investors loved it. The President and White House pulled the strings perfectly so that it appeared that the Federal Reserve Board members were not acting out of their own accord. The magnificent performance began at the end of December and after a few missteps and crossed strings, the show ran perfectly. First, the Fed puppets conveyed that they would stop shrinking the balance sheet and then that they would stop raising the Fed Funds rate. Some even suggested that rate cuts were behind the curtain. Investors clapped and cheered like little kids at a Punch and Judy show and the financial markets roared to their best first quarter in years.
So what did we learn the last four months?
Rule #1: Don’t fight the Fed.
Rule #2: The POTUS wants to be re-elected.
Rule #3: This Fed is completely controlled by the POTUS.
Bottom line is that the Fed is being HEAVILY pressured to cut interest rates over the next two years. And if they don’t do it then their TV talking head replacements will do it for them. As short-term rates are cut, the economy will get more pumped, scaring longer term fixed income investors which should then steepen the yield curve. Even though the curve just inverted last month, that is probably the last we will see of it unless credit breaks. Economic data should start to improve through the summer, unless the trade wars and a closed Mexican border impede global commerce. The equity markets are trying to tell you that the economy is going to get better. The Treasury bond markets disagree, but the Credit markets choose the side of equities.
I didn’t foresee the White House calling all the shots at the Fed. I thought in November that an independent Fed would remain on track to build up reserves for the next credit crisis. When the Govt shutdown stopped the economy and the markets fell apart in December, I thought that it was prudent to be overly cautious. So the quick caving of the Fed in December caught me flat footed and under-invested in U.S. equities in the first quarter. I applaud any investor who was positive in both December and in the Q1.
From here, you have to have some risk on the books. I want my tallest stack of chips to be in the Emerging Markets which have a valuation advantage, a shot at more green shoots and a potential U.S./China trade deal. But with short-term rates falling and the curve steepening, you will have a tailwind to most equity sectors and geographies. Among U.S. sectors, plenty of great companies to own in the Technology and Consumer spaces. Be picky in Healthcare with all the moves and battles in Washington. And of course, I still want to own bonds, but maybe a bit shorter in maturity now. Also would stick to higher quality but still surprised by how well junk bonds have done. With inflation looking grim in Europe and now in the U.S., a big tailwind for Gold might be gone so I wouldn’t have many chips there. These are crazy times. This show has more twists than a Jordan Peele film so sit back and try to enjoy it