Covenant Weekly Market Synopsis for June 7, 2019

June 10, 2019

Last Week Today. The Department of Justice (Apple and Alphabet – aka Google) and the Federal Trade Commission (Facebook and Amazon) announced antitrust investigations into the market power held by large technology platforms. For a change, Republican and Democratic lawmakers agree on something – big technology companies are too influential in Americans’ political and economic lives. Change (and massive legal bills) are coming to these companies. | While visiting the United Kingdom, President Trump appeared to extend a hand to the country, hinting at a trade deal if Britain leaves the European Union. | The World Bank cut its 2019 global growth outlook from 2.9% to 2.6%, citing risks from trade tensions. | President Trump announced an agreement with Mexico to reduce the flow of migrants to the southern border, thereby eliminating the imposition of escalating tariffs set to begin today.

Global equities bounced after four consecutive losing weeks as a thematic trifecta leaned toward risk takers:

  • Monetary Policy: Comments from the Federal Reserve fell in line with market expectations for interest rate cuts.
  • International Trade: Progress, and ultimately an agreement, was reached with Mexico, preventing the opening of a new front in the U.S. trade war.
  • The Economy: Economic data was sufficiently soft to keep the Fed on the path toward rate cuts… at least that’s how the market interpreted the May labor market report.

Domestic equities led the way, with the major indices rising 4% or better, while international developed market stocks gained 3.2% (MSCI EAFE Index). Looking back, equity markets have moved a lot, but they’ve made little progress since early 2018. Indeed, for the last 18 months, the S&P 500 has mostly remained in a 15-percentage-point-wide channel centered around 2,650, periodically supported or bashed by one or more of the themes listed above.

For specific weekly, month-to-date and year-to-date asset class performance, please click here.

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Sources: Bloomberg Finance, L.P., and Covenant Investment Research.

Extended periods of relatively flat performance are not unusual in any asset class. However, it’s easy to get distracted by the news headlines and associated volatility that wreak havoc with the human mind and effective decision making. There are several ways one can combat some of the obvious behavioral biases that impact all humans: work with an experienced advisor to create a financial plan, construct thoughtful portfolios that allow you to “stay in the game” and not be a forced seller, and education. On the latter topic, we are introducing a new series within Covenant’s Weekly Synopsis focused on the human mind and investing.

Behavioral Finance. Over the coming weeks, we will begin a knowledge series on behavioral finance, called “A Look at How the Mind Works Against Successful Investing.”

Behavioral finance is, at its core, the application of psychology to how financial decisions are made. Traditional financial models assume that market participants always act in a rational and wealth-maximizing manner, which is why traditional models typically fail to make accurate, detailed predictions. In contrast, behavioral finance studies mental shortcuts humans have developed that may have been useful to the survival of the species, but that lead to irrational investment decisions. The difference between traditional financial models and behavioral finance models is summed up nicely by professor Meir Statman, PhD, “People in standard finance are rational. People in behavioral finance are normal.”

This series should be an interesting and informative look at how emotional biases and cognitive errors affect perceptions and, ultimately, investment decisions. We hope that by studying and sharing critical tenets of behavioral finance, we can help expand literacy on the topic, leading to a community of better investment decision makers.

Capitulation. The bond market has been screaming that monetary policy is too tight (i.e., the deeply inverted yield curve) and it appears that the Fed is finally coming to a similar view. Early last week, James Bullard, President of the St. Louis Fed, suggested the Fed may have gone too far with its rate hiking campaign. “A cut may be warranted soon…The narrative on global trade has darkened. Monetary policy looks too restrictive in this environment.” To be fair, Bullard has been suggesting for some time now that Fed policy may be too restrictive.

On the other hand, Fed Chairman Powell’s 180-degree pivot from December 2018’s hawkish stance is nearly complete. During a speech in Chicago on Tuesday, in his prepared remarks, Powell said “We do not know how or when these trade issues will be resolved. We are closely monitoring the implications of these developments for the U.S. economic outlook and, as always, we will act as appropriate to sustain the expansion with a strong labor market and inflation near our 2% objective.”

The Fed is unlikely to cut rates at their meeting next week (June 18-19), but they could certainly set the stage for a rate cut at their meeting in July. By the way, based on the futures market, investors are expecting the Fed to undo all the rate hikes from 2018 by cutting rates a full 1% by year-end 2020 (-0.65% in 2019 and -0.30% in 2020).

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Right on Cue. If the Fed needed an economic nudge to consider cutting interest rates, Friday’s employment report was tantamount to a shove in that direction. Nonfarm payrolls rose by only 75,000 (vs. the consensus estimate of 175,000) in May. Moreover, the two previous months’ jobs gains were revised down by a total of 75,000, resulting in a net employment change of zero. As the chart below highlights, a month of low job creation is not unprecedented, but it (along with fading wage pressure which registered 3.1% year-over-year in May vs. 3.4% in February) hints that trade disputes are having a real effect on business confidence.

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Be well,

Justin