The stock market has been in a wide trading range for the past 18 months, and it currently sits at the top end of that range at approximately 2900 on the S&P 500 index (SPY). The tug of war between bulls and bears, or what I see as the Trump and Powell puts versus reality, has come to another critical juncture. Will we break out to new all-time highs and establish a new elevated trading range for the next several years or has the bull market finally run its course?
The Trump Put
It's no coincidence that the stock market peaked each time President Trump escalated trade tensions with his tariff policies. The initial tariffs that were placed on washing machines and solar panels coincided with the market peak in January 2018. It peaked again in September when Trump placed a 10% tariff on $200 billion of Chinese goods. The third escalation occurred as the market hit all-time highs when Trump raised the tariff from 10% to 25%. Stock market performance is very important to President Trump, as it has performed well during his presidency, so he likes to use it as his personal report card.
Therefore, when stock prices start to fall, he takes to Twitter to cajole the computer algorithms with keywords that will trigger buy programs. This is the Trump put, but it may not work indefinitely. It appears that President Xi is not entertained by Trump's antics. He has not yet agreed to meet with Trump to discuss trade at the G20 meeting. Additionally, China is openly strengthening ties with Iran in the face of yesterday's oil tanker attacks. I think Trump has painted himself into a corner. If he is rebuffed by the Chinese leader, he will have no alternative but to escalate trade tensions again. It will be very difficult for his administration to claim that negotiations have done anything other than fall apart.
Trump's tariff policies are already weighing heavily on the manufacturing sector in the US, which is slowly bleeding jobs and momentum, as evidenced by the deteriorating ISM and PMI manufacturing surveys. When the Trump put expires, he will undoubtedly call on the Fed to take the baton, as he has done each time the market failed to respond to his Twitter feed.
The Powell Put
Stock market performance is just as important to the Fed as it is to President Trump. Monetary policy was designed at the very beginning of this economic expansion to inflate financial asset prices in hopes that it would help the Fed achieve its mandate of full employment and stable prices. When the market has taken a tumble, Fed governors have been quick to cajole the computer algorithms with rhetoric the same way that Trump likes to do. It certainly worked at the beginning of this year when Chairman Powell took a more dovish tone, following a near 20% decline in the S&P 500, which has come to be known as the Powell put.
Yet, now that the Fed has achieved its mandate and the stock market is flirting with all-time highs, investors are suddenly demanding rate cuts after one disappointing employment report. Expectations are that we will see that rate cut at the July meeting. I think investors will be disappointed, as the Fed has historically been a reactive body when it comes to policy. Furthermore, Chairman Powell does not want to look like he is being political, and responding to Trump's demands for a rate cut will raise serious questions about the Fed's independence.
I see no possible way for the Fed to substantiate a rate cut with the unemployment rate at 3.6%, the rate of inflation at 2% and the stock market at all-time highs. Still, if the Fed does cut rates, it will be a foreboding sign for the economy and the stock market at this stage in the economic cycle.
There have been seven rate cuts that took place after at least one rate increase since 1984. While the first five that occurred were followed by solid performance for the S&P 500 during the 12 months that followed, the last two in January 2001 and September 2007 were disasters. Those two occurred near the end of lengthy economic expansions, which is similar to where we are today. Therefore, the Powell put may not be as powerful or bullish as investors perceive it to be.
The reality is that we are in the middle of a corporate earnings recession that is bound to get a lot worse before it gets better. President Trump's trade policies will only worsen this situation and rate cuts by the Fed will do little to alleviate it. Bulls contend that the stock market is not that expensive at 17 times forward earnings estimates when the historical average has been approximately 15-16 times. The problem is that estimates are always too high just prior to downturns, and the market can very quickly become expensive as estimates are revised lower.
I think that if investors look past the distraction of this year's slew of overpriced IPOs, they will see that the market has been slowly unraveling from the bottom up. There are several issues that tell me the June rally is probably a head fake, soon to be followed by a resumption of the decline that started in May. The first is that the volume has been pitiful as the market has surged higher. This rally would be a lot more convincing if the volume was increasing on the rallies and declining on the corrections. We have seen the exact opposite.
The second issue is that looking at the NYSE Composite index, which includes more than 2,000 companies, we have continued to see lower highs and lower lows over the past 18 months. Performance in the overall stock market has been narrowing during this time, as fewer and fewer companies are participating in the rallies.
Lastly, the performance of small-cap stocks is particularly alarming because these are the names that are domestically focused. The Russell 2000 index (IWM) has not been able to climb above its 50- or 200-day moving averages.
Rather than hang my hat on a Trump or Powell put, I'd rather buy puts on the S&P 500. I think the best-case scenario is that we hold the December lows on the S&P 500 later this summer, but the worst case is bear market that finds us at lower levels. I continue to maintain my core exposure to the stock market, but I've hedged my exposure with option spreads focused on what I view as the most vulnerable areas of the stock market.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Lawrence Fuller is the Managing Director of Fuller Asset Management, a Registered Investment Adviser. This post is for informational purposes only. There are risks involved with investing including loss of principal. Lawrence Fuller makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made by him or Fuller Asset Management. There is no guarantee that the goals of the strategies discussed will be met. Information or opinions expressed may change without notice, and should not be considered recommendations to buy or sell any particular security.