Summertime and New Potential Rate Cuts

By Ketu Desai

What a difference a month makes. After the S&P traded down nearly 7% in May, the market bounced back to hit new highs in June. Central banks around the world continued their dovish tone, and are now ready to start an easing cycle. The ECB signaled that the bank could roll out fresh stimulus as soon as July, which could include further lowering an already negative policy rate and/or starting a fresh round of quantitative easing. The Chinese added a new infrastructure program to their long list of pro-growth policies. We have had or are expecting rate cuts from Australia, India, New Zealand, England, Malaysia, Philippines, South Africa, Egypt, Indonesia, and South Korea. Meanwhile, the market is pricing with near certainty that the Fed will cut rates in July. The latest comments from Fed officials indicate that it will likely be a 25bps cut, as opposed to 50bps that some were hoping for. Persistently below target inflation and weaker economic data are spurring a new easing cycle. Corporate spending and confidence continue to deteriorate, the latest read on manufacturing PMI indicates considerable economic slowing, with many foreign economies in contraction. The US consumer, the strength of the global economy, is even showing some cracks, as the latest confidence and employment numbers have been worse than expected. While the economic data is weaker, global policy makers are stimulating, while the long run implications are unknown, and possibly quite negative - for now, investors should not fight it.

A global easing cycle has broad implications across asset classes. The most immediate impact is lower yields, the 10-year traded below 2% during the month. Interestingly, despite lower yields, the 10s/2s spread has actually widened from below 15 bps at the end of the first quarter, to nearly 30 bps. Equities on average perform well after the Fed's initial rate cut, especially if we are not in recession. In particular, after the Fed's initial rate cut, when we are not in recession, the average 12M forward historical return for equities is in the mid-teens with all historical cases since 1971 delivering positive returns. Multiples also expand, and this time it might not be any different - we have low inflation, low rates, equities yielding more than double the 10YR, poor YTD equity flows, and the expectation of reaccelerating earnings in the fourth quarter and into 2020.

Perhaps the most notable market move during the month was the dollar breaking below its 200-day moving average. A weaker dollar is positive for many asset classes including commodities and emerging markets. Gold had a huge month up 7.8%. The weaker dollar also bodes well for emerging market assets outperforming domestic. While the S&P has surpassed its previous highs, EM equities are still more than 10% below their January 2018 high, and trade nearly 40% cheaper.

The recent move up does not give much bullish confirmation, as it has been led by defensive sectors such as utilities, real estate, and consumer staples. For the broader equity market to sustain this rally, it will need more participation from cyclical groups such as semiconductors, small caps, financials, and materials. Towards the end of June, we saw just that, investors rotating out of defensives into cyclicals. The S&P has essentially had a “triple top" at near current levels, for a meaningful break-out look for the cyclicals to lead.

Looking forward the market will continue to digest the G20 meeting, to see if we can get real progress on trade. July will also be a busy month with earnings, more economic data, and a Fed meeting.


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