Switch From Trade Fears To Rate Cut Hopes Lifts Stocks

Summary

Despite this sharp rise in the indexes last week, I'd still say stock picking will beat index funds, especially with the Nasdaq 100, where several flagship stocks are under investigation.

The biggest financial news last week in the U.S. was the continued collapse in Treasury bond yields. The 10-year Treasury yield hit 2.053% last week.

On Thursday, the European Central Bank said that it would hold key interest rates steady through the first half of 2019, raising speculation that it might cut key interest rates in the second half.

Originally published on June 11, 2019

The financial news media has switched its obsession from trade tariffs to a coming Fed rate cut, so the news media is finally reporting some more positive news for a change and the market "melted up" by almost 5% last week, recovering more than two-thirds of its losses suffered in the entire month of May.

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Despite this sharp rise in the indexes last week, I'd still say stock picking will beat index funds, especially with the Nasdaq 100, where several flagship stocks are under investigation. Google (GOOG, GOOGL) is under Justice Department scrutiny in a potential antitrust probe, and The Wall Street Journal has also reported that the Federal Trade Commission is probing how Facebook's (FB) business practices impact digital competition.

The Nasdaq 100 is also being adversely impacted by Tesla's (TSLA) woes, so Nasdaq's former flagship index is under siege as many of its mega-cap stocks falter. Fortunately, I do not own Google, Facebook, or Tesla, so I have not been adversely impacted by these Nasdaq 100 flagships' recent gyrations.

(Navellier & Associates does not own Tesla, Google or Facebook in managed accounts and our sub-advised mutual fund. Louis Navellier and his family does not own Tesla or Google or Facebook in personal accounts.)

What's Behind the Global Race to Zero (or Negative) Interest Rates?

On Thursday, the European Central Bank (ECB) said that it would hold key interest rates steady through the first half of 2019, raising speculation that it might cut key interest rates in the second half! ECB President Mario Draghi, in a news conference, said that the ECB stood ready to lower rates or implement other measures if needed. Furthermore, Draghi said that the ECB "stands ready to act and use all the instruments in the toolbox," but how many tools are still in their toolbox when rates are already negative?

The biggest financial news last week in the U.S. was the continued collapse in Treasury bond yields. The 10-year Treasury yield hit 2.053% last week. This collapse in Treasury rates is primarily being caused by (1) foreign capital flight, (2) a lack of inflation, and (3) weaker-than-expected economic news. As a result, the Fed Funds futures market is now forecasting two 0.25% Fed key interest rate cuts. Please be aware that the Fed Funds futures market is volatile, but I think it is safe to say that at least one Fed rate cut is now increasingly likely this year. The Federal Open Market Committee (FOMC) statement tomorrow (June 12th) will likely be pivotal, as will Fed Chairman Jerome Powell's following press conference.

Last Tuesday, Chairman Powell said that the Fed is watching how trade disputes have flared in recent weeks, and they are monitoring the impact of those disputes on economic growth. Specifically, Powell said that the Fed will "act as appropriate" to sustain the current economic expansion. Powell added that, "We do not know how or when these 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 symmetric 2% objective." Translated from Fedspeak, Powell made it clear that the Fed is now considering a key interest rate cut.

On Wednesday, the Fed released its Beige Book survey in conjunction with its upcoming FOMC meeting. The Beige Book survey said that the U.S. economy expanded at "a modest pace overall" from April to mid-May, but growth was partly held in check by labor shortages and worries over tariffs on China.

The good news on the tariff front is that Mexico sent a big delegation to Washington, D.C., to cooperate with the Trump Administration on the border crisis in a very serious attempt to avoid a 5% tariff on Mexico's exports to the U.S. Since the U.S. is by far Mexico's largest trading partner, there is no doubt that the U.S. has sufficient leverage, and Mexico wanted to cooperate, since its economy boomed under NAFTA. On Friday, President Trump suspended any tariffs on Mexico and on Twitter said that Mexico "has agreed to take strong measures" to stem the flow of Central American migrants into the U.S.

In the meantime, the proposed NAFTA change that both Canada and Mexico agreed on is unlikely to be ratified by the House of Representatives. Apparently, the UAW in Canada, Mexico, and the U.S. had all approved of the NAFTA changes, but the Democratic House does not want to provide the Trump team with a pro-union "win," so the change recommended by the UAW has not yet cleared the House.

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On Thursday, the Commerce Department reported that the trade deficit declined 2.1% in April to $50.8 billion as exports and imports both declined 2.2% to $206.8 billion and $257.6 billion, respectively. Although a shrinking trade deficit is always welcome, this will likely cause economists to cut their second-quarter GDP estimates a bit, due to falling exports. Boeing's (BA) near-term woes affiliated with the 737 Max are also reducing U.S. exports and GDP growth. Interestingly, the trade deficit with China rose 30% in April to $26.9 billion, while the trade deficit with Mexico declined 14% to $8.2 billion. Since both China and Mexico are very dependent on exports to the U.S., I expect these trade disputes to be resolved.

Most Economic Indicators Point Toward a Slowdown, Fueling Fed Rate Cuts

The Commerce Department on Tuesday reported that factory orders declined 0.8% in April after rising 1.3% in March. New orders for durable goods declined 2.1% in April after rising 1.7% in March. Weak orders for transportation equipment accounted for the bulk of the decline in durable goods orders and fell 5.9% in April. The manufacturing sector is clearly being impacted by Boeing's woes and weak auto sales.

Speaking of the manufacturing sector, the Institute for Supply Management (ISM) last week reported that its manufacturing index slipped to 52.1 in May, down from 52.8 in April. Economists were expecting a small drop to 52.6, so this was a big surprise. The production component declined to 51.3 (the lowest reading since August 2016), while the supplier component declined to 52 in May (down from 54.6 in April). Concerns over tariffs may continue to weigh on the manufacturing sector in upcoming months.

On Wednesday, ISM reported that its non-manufacturing (service) index rose to 56.9 in May, up from 55.5 in April. Fully 16 of the 17 service industries surveyed reported that they were expanding in May. The ISM components that were especially strong were business production, rising to 61.2 in May (from 59.5 in April), and new orders rose to 58.6. This strength in the service sector is very encouraging for GDP growth, since approximately 70% of GDP growth is attributable to the service sector.

The other big news was that the Labor Department reported on Friday that 75,000 payroll jobs were created in May, substantially below economists' consensus estimate of 180,000. Also significant was that March and April payrolls were revised down by a cumulative 75,000 jobs. Average hourly earnings rose 0.2% and have risen 3.1% in the past 12 months. The unemployment rate remains at 3.6%, near a 50-year low. Clearly, this disappointing payroll report will increase the pressure on the Fed to cut interest rates.

Inflation indicators come out this week, and they should be tame. The Energy Information Administration (EIA) reported that U.S. crude oil inventories rose by 6.8 million barrels in the latest week, while gasoline and distillates (diesel, heating oil, jet fuel, etc.) rose by 3.2 million and 4.6 million barrels respectively. This was a big surprise, since analysts expected crude oil inventories to decline by 1.7 million barrels. As a result of the growing glut of crude oil and refined products due to record U.S. energy production, U.S. energy exports are expected to soar, and more supertankers have been diverted to the Gulf of Mexico.

The fact that crude oil prices are declining while Russia has production problems due to contamination in its largest pipeline to Europe is amazing. In theory, if Russia fixes its pipeline problem and production rises, crude oil prices might soon "crack" $50 per barrel in the upcoming months. Iran and Venezuela crude oil production could also possibly rebound somewhat if these countries come to the negotiating table. No matter how you look at it, the U.S. is now fully in control of worldwide crude oil prices, thanks to record U.S. production; so I expect the deflationary pressure from lower crude oil prices to persist for the next several months, which will help central banks around the world to cut key interest rates.

Disclosure: *Navellier may hold securities in one or more investment strategies offered to its clients.

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Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.