The S&P 500 trended down most of last week, but closed up strongly on Friday to set a new record high of 2182.87, based in large part on another strong jobs report, including positive revisions to previous months.
Welcome to August! With most Europeans on vacation and many Americans planning a late summer holiday, the stock market is essentially being neglected. Fortunately, we have seen some positive second-quarter sales and earnings released; but there is no doubt that the stock market is now being distracted by outside events like (1) crude oil closing at $39.51 last Tuesday, (2) President Obama calling Donald Trump “unfit to serve” for over five minutes in a press conference, and (3) a Wall Street Journal report of a private plane with $400 million in cash delivered to Iran in exchange for four hostages a few months ago.
The Presidential campaign season is usually positive for the market since candidates try to promise voters anything and everything; but this time around they are both fomenting fear of “the other,” so we might as well get used to political distractions until after the election, since this mudslinging is not going to end.
I am also concerned about what will happen to crude oil prices in September when seasonal demand usually falls. If crude oil can fall below $40 per barrel during peak summer demand, then $35 per barrel is likely in the fall and $32 per barrel by year’s end. In the event that crude oil breaks $30 per barrel, it could really hurt U.S. GDP growth, since so many states now depend on crude oil production.
August is generally a weak market month, except in election years. Last Monday (in “August Intra-Month Pattern”), Bespoke Investment Group showed that the average August of the last 30 years (1986-2015) delivered negative (-0.62%) average returns, but the Augusts in the seven Presidential election years rose by an average 0.77%. This year, I don’t know if we’ll see a rising August if our Presidential candidates continue slinging mud instead of promising a better economy under their proposed policies.
I hate August! It is not the hot weather I hate most, but the market shenanigans. For instance, last August 24, the market’s “circuit breakers” stopped trading in 1,278 stocks and the ETF specialists took advantage of that situation for over 90 minutes to pick off unwary investors by trading ETFs at up to a 35% discount to their underlying net asset value. These ETF specialists annoy me to no end. In my opinion, when the NYSE cannot price stocks right due to circuit breakers, ETFs with these stocks should also be suspended.
On that same day (August 24, 2015), an academic study was published by the Stanford Business School (titled “Are Exchange-Traded Funds Dumbing Down the Markets?”). It reviewed a study by professors at Arison University (Israel), Stanford, and UCLA which pointed out that ETFs are more expensive to trade and are taking individual stock analysis out of the equation, hence “dumbing down” the stock markets.
This study also warned that “there may be another shoe to drop” as Wall Street has increasingly pushed algorithms to trade stocks and ETFs. This rising ETF demand is increasingly driving the market. The big asset gatherers like to assure investors that they are not charging much of a management fee, but they fail to disclose that the real money in ETFs comes via the wide bid/ask spreads these ETF specialists charge.
In the process, investors are being systematically duped by some big ETF firms. In my opinion, investors are increasingly being lured into passive ETF investments that systematically churn their ETFs every 90 days, making lots of money via bid/ask spreads (instead of fees) during each ETF quarterly rebalancing as well as in market crisis conditions – such as happened in the collapse of the China stock market bubble on August 24, 2015.
So, as many traders go on vacation in August, I take a deep breath and wait for another ETF shenanigan to occur, most likely triggered by an unscrupulous short seller spreading rumors and taking advantage of thin market conditions when most of Europe is on holiday and many folks on Wall Street are also absent.
That is the bad news. The good news is that stock buy-backs also tend pick up in August as the second-quarter announcement season winds down and we enter pre-announcement guidance season. I have also noticed a seismic shift back to domestic, small-to-mid capitalization stocks since Brexit. Specifically, the Russell 2000 posted its biggest surge in 4½ years after Brexit. After such a dramatic rise, I’ve noticed that Wall Street’s investment strategist allocations are now suddenly calling for a lot more small-cap stocks.
Central Bank Shenanigans Also Tend to Escalate in August
Clearly, we live in a strange new world where deflation rules and central banks seem to be losing control. Specifically, central banks in Japan and England acted last week. In Japan, government bond yields rose from -0.3% to 0% due to the Bank of Japan boosting its super-caffeinated version of quantitative easing.
On Thursday, the Bank of England cut its key interest rate to 0.25% from 0.5%, which represents its first interest rate cut in seven years and the lowest rate in the 322-year history of the British central bank. The Bank also boosted quantitative easing by 60 billion pounds ($79 billion), of which up to 10 billion pounds were earmarked for corporate bonds. Essentially, the Bank of England is following the European Central Bank by pumping money into the banking system to buy corporate bonds, which fosters low interest rates, which in turn fuels more stock buy-backs, since corporations can borrow money at ultra-low interest rates.
The official statement from the Bank of England said that “The outlook for growth in the short-to-medium term has weakened markedly,” and slashed its annual forecasted GDP growth to only 0.8%, down from its previous forecast of 2.3%. At Governor Mark Carney’s press conference, he reiterated that interest rates are expected to remain low for an extended period of time and that Britain is facing a period of uncertainty.
The Bank of England also hinted about another rate cut (perhaps to 0%) later this year. Governor Carney was repeatedly asked about negative interest rates at his press conference. For the record, Carney made it crystal clear that negative interest rates would not occur under his watch, but the fact of the matter is that deflationary forces are spreading, so no major central banks will likely be raising key rates anytime soon.
In America, the Labor Department announced that 255,000 payroll jobs were created in July, but the most important number could be that the average hourly earnings rose 0.3% (8 cents) to $25.69. In a time of deflation, wages have risen 2.6% in the past 12 months, so the wage inflation that the Fed wanted to see is finally unfolding. To me, this means the Fed is now more likely to raise key interest rates later this year, but I expect the Fed will wait until December, after the November Presidential elections, to raise rates.
Multiple Fed regional bank presidents said that a September key interest rate hike is still “on the table,” but with business spending shaky and crude oil prices falling, there is no way the Fed will raise interest rates in September. The Fed’s intention may be clarified during Fed Chairman Janet Yellen’s Jackson Hole speech on August 26, so if she hints that the Fed may raise rates in September, we might see a brief market sell-off.
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