The S&P 500 is up 17.7% year to date as of June 21st. That’s a fantastic run for an economy headed in the wrong direction. It’d be amazing performance even if the economy was seeing accelerated growth. Specifically, the S&P 500 hasn’t been up 15% headed into the last week of the first half since 1998. Another interesting tidbit is most metrics don’t show investors are euphoric. That’s possibly because people are fearful of a recession and the trade war with China.
The CNN Fear and Greed index is at 52 which is neutral. The AAII individual investor sentiment survey showed 29.5% of investors were bulls and 32.1% were bears. It’s weird to see more bears than bulls near record highs. As of June 19th, the NDR trading sentiment composite for the S&P 500 was at 45.56 which is neutral. One place where there is euphoria is the treasury market as its NDR reading was at 67.34 which is excessive optimism.
What First Fed Rate Cut Means
It makes sense to start thinking about how assets will react to the first Fed rate cut because there is a 100% chance the Fed cuts rates in July according the Fed funds futures market. Traders are so confident in a cut that there is even a 32.3% chance the Fed cuts rates by 50 basis points. The table below shows how various assets and asset classes do after the first rate cut of the cycle.
Morgan Stanley: "What Happens When the #Fed Cuts & the Curve Steepens?"
Returns after first cut: pic.twitter.com/W6JoZEqBYX
— liuk (@liukzilla) June 21, 2019
It’s tricky because either this is a precautionary rate cut which will be reversed in the next few quarters when the economy rebounds or this is a rate cut before a recession.
As you can see, the S&P 500 only gives 2% returns after the first cut. That’s pretty bad when you consider more than all of those gains come in the first 3 months where stocks increase 2.9%. High yield bonds (excess returns over US Treasuries) do the worst as they fall 13.8% and Brent oil does the best as it increases 13.5% over the next year. WTI oil increased over 9% in the past week because of the dollar’s decline and the geopolitical tensions between Iran and America. That was the best week for oil since December 2016.
Terrible Markit PMI
The June Markit Flash PMI was even worse than the May PMI which puts it on the cusp of showing the economy is contracting. This makes it look like a recession is coming soon although it’s still too early to tell. The flash composite index fell from 50.9 to 50.6 which is the lowest reading in 40 months. Anything below 50 is a contraction. As you can see from the chart below, the services activity index fell from 50.9 to 50.7 which is also a 40 month low.
With losses totaling 8.5 points since January, the future expectations index within the Markit Services PMI is now down to 57.8, its lowest in the 9.5-year history of the series (begun in October 2009) and almost 13 points (18%) below the long-term average. pic.twitter.com/bbOJCyiGLA
— Jeoff Hall (@JeoffHall) June 21, 2019
This is one of the worst readings this cycle. Furthermore, the future expectations index fell to 57.8 which is the lowest reading in the 9.5 year history of this series. It is 13 points below its average and down 8.5 points since January.
The manufacturing sector was even worse as the manufacturing PMI fell from 50.5 to 50.1 which is the lowest reading in 117 months. The manufacturing output index fell from 50.7 to 50.2 which is a 37 month low. Keep in mind, the flash readings are just from the first half of the month. However, this index was similarly weak in May meaning it might not jump higher in the 2nd half of June. The payrolls index in this report was the weakest since April 2017 as Markit predicts there will be 140,000 jobs created in June which isn’t terrible as there were only 75,000 added in May.