August 5, 2019 Market Report - The Fed and China: Headline Risk on Both Sides of our Border

Ann Miller |

The Fed and China:  Headline Risk on Both Sides of our Border

The Quick Take

  • The Federal Reserve is confusing the markets:
    • Last week the Federal Reserve lowered interest rates signaling concern for a weakening economy.
    • Last December, the Federal Reserve raised interest rates signaling concern for inflation which is a byproduct of a strengthening economy.
  • Continuing uncertainty about a trade war with China:
    • China has allowed its currency to drop to new lows amid long-term concerns over manipulation of their currency to gain economic advantages.
    • U.S. Responds with mention of new tariffs.
  • From a technical analysis standpoint, the size of this selloff is unremarkable although the speed can be unsettling. 
    • The Dow was near new highs in April and retreated (7.5%).  It achieved new highs again in July and has retreated (5.4%).
    • It is perfectly normal for the markets to reverse one-third to one-half of its gain before resuming an uptrend.
    • The Dow is currently at 25,717.  Any close below the 24,700 level would become a greater cause for concern.
  • The tragedies in El Paso and Ohio exacerbate the market mood.  Prayers for all.

U.S. Stocks are down sharply today as China has allowed its currency to drop to new lows by keeping the currency below its ‘fair’ market equilibrium price through government currency controls.  The Chinese tie their currency only to the U.S. Dollar rather than a wider basket of international currencies.  This involves buying the U.S. Dollar to strengthen it, which in turn weakens their own currency.  The advantage is that Chinese imports to the U.S. become more attractive versus our domestic goods.  In response, the U.S. has threatened further tariffs on Chinese goods. 

Last week, the Federal Reserve lowered short-term interest rates and while the move was widely anticipated, it raised a question in the marketplace as to whether it was just a one-off adjustment to policy or whether it’s the start of a longer-term cycle of interest rate cuts.  The purpose of a rate cut is to help stimulate the economy.  This signals that the Fed thinks the economy is weakening, a negative for the markets and thus selling begins.   While U.S. economic data is generally strong, especially consumer demand, overall continued global growth is providing conflicting data.  One concern is that of an inverted yield curve.  This occurs when short-term interest rates are higher than long-term interest rates, and that’s often a signal of an impending recession in the next year.  Plus, U.S. interest rates are significantly above those in other major developed countries, and that has driven up the value of the U.S. dollar, which in turn tends to make U.S. exports less competitive and slows our economy.

With that said, the markets have enjoyed strong performance since the December sell-off which was the worst December since the great depression.  That occurred in response to the Federal reserve raising interest rates a fourth time in 2018 – a surprise to the markets.  The weakness in the markets last week was predicated on the Fed lowering interest rates last week.  Simply put, the Federal Reserve Chairman and committee members appear to be confused by conflicting data.  Overall, U.S. economic numbers are strong so words and actions by the Fed are not serving the markets.  When we couple this with headlines about Chinese tariffs, the markets are jittery.   We believe the U.S. and China are posturing and a trade deal will be worked out over time.  Neither side benefits from prolonged “trade war”.

From a technical analysis standpoint, the size of this selloff is unremarkable although the speed can be unsettling.  The Dow was near new highs in April and retreated (7.5%).  It achieved new highs in July and has retreated (5.4%) to close today at 25,717 points.  Our downside target was 25,652 which was reached earlier in the day.  It is perfectly normal for the markets to retreat one-third to one-half of its gain before resuming an uptrend.  We would like to see the Dow hold this level.  Should it drop further, the next watch area would be 24,700.  Any close below that level would become a greater cause for concern.  The markets have numerous risk categories. There are many but to name a few: interest rate risk, currency risk, individual stock or sector risk and perhaps the biggest is headline risk – essentially news and rumors.  Today was headline risk showing its power.  It was a reason to take profits from the recent highs in the markets amid uncertainty.  The markets prefer knowing the bad news versus any type of uncertainty.

Our Affinity Capital Portfolios, as designed, have held up better than the market indices today.  A continued approach of broad diversification and strategic use of securities has served us well.  Please call to schedule an appointment – we always welcome an opportunity to visit.

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