Central Banks Becoming Dovish

By Ketu Desai

The financial story of the year continues to be the rapid dovish pivot by global central banks. Just last December, we were expecting multiple rate hikes, now we appear to be embarking on a global easing cycle. The paradigm shift is summed up well by the Reserve Bank of Australia Governor, “whether or not further monetary easing is needed, it is reasonable to expect an extended period of low interest rates." While the ECB did not cut rates this meeting, it iterated the same dovish tone, as it is teeing up a multifaceted policy response as early as September, including possibly restarting quantitative easing. The Fed started its easing, cutting rates by 25 bps. In aggregate, it is expected that by year-end, 21 central banks will have eased monetary policy.

With over $13 trillion in negative yielding debt, including negative yields going out as far as 10-years across Europe and Japan, we appear to be heading toward a world in which there is no alternative to equities (commonly referred to as TINA among market participants). Investors have been slow to embrace this world, as nearly $50bn has flowed out of equities this year. Further, according to AAII, bears outnumber bulls, and long U.S. Treasuries is the “most crowded trade" for the second month in a row, according to the BAML fund managers' survey. This is despite earnings coming in better than expected. In aggregate, companies are reporting earnings that are 5.4% above the estimates and revenue 1.2% above estimates with nearly 80% of companies beating estimates.

The earnings reports and economic data during the month highlight a few themes. First, the domestic consumer remains strong, we had a very strong retail sales number in July, jobless claims are at near 50-year lows with disposable personal income up nearly 5% in the latest report. Consumer businesses at the banks were strong, for instance, Bank of America's consumer business was up 13%, 11% at Citigroup, and 22% at JPM. The strong consumer was further confirmed by earnings from Chipotle, Visa, Coca-Cola, Pepsi, Starbucks, Expedia, Mattel, McDonald's, and Hasbro. The strength of the consumer, which makes up more than two-thirds of the economy, helps mitigate recession risk. Secondly, industrials, manufacturing, and autos have slowed, most of the world's manufacturing PMIs are now indicating contraction. That has been backed up by weak earnings from Caterpillar, Boeing, 3M, CSX, Ford, Tesla, and Dow. Lastly, capital expenditures or business investment have slowed considerably, outside of technology spend. As the latest GDP report highlights, business investment fell in the second quarter for the first time since early 2016, which is further backed up by months of weak durable goods orders. Tech spending has been the only area of any meaningful growth, with spend expected to hit $4 trillion this year. In particular, the secular theme of software and cloud spend continues to benefit, with cloud businesses at Microsoft, Amazon, Salesforce, and Adobe growing 64%, 37%, 24%, 22%, respectively.

The rally until recently, has been driven by defensive sectors such as consumer staples, utilities, and real estate, that started to change in late June and now into July. Most notably, semiconductors led the rally during the month and are up nearly 20% since the early June low with SMH (semiconductor ETF) hitting an all-time high during the month. Semiconductors are the modern-day Dow Transports, a leading indicator that can confirm a bull market. For further confirmation, look for a rally in other cyclical sectors such as materials, industrials, and small caps.

Looking forward the market will remain focused on earnings, economic data, and if we can make any progress on trade.


Ketu Desai is the Principal of i-squared Wealth Management Inc. ( www.isquaredwealth.com ), an investment management firm based in New Jersey. ketu@isquaredwealth.com