The Federal Reserve cut its discount rate for the first time since 2008 at its July meeting. The cut represents a dramatic reversal from hawkish to dovish and reverses the last rate hike from Christmas, something which many see as a mistake, in hindsight.
The news of a rate cut, which is normally seen as positive for markets, quickly turned to a ‘sell the news’ event. Investors are now fretting over whether the cut is more corrective rather than the start of a new easing cycle, which is exactly what many are calling for.
There was much confusion about the need for the cut. On the surface, you could be forgiven to think all is well. Equities were at all-time highs and American unemployment is all time lows. Yet, outside of North America, things are not as strong. While it’s arguable that other economies are outside of the Fed’s mandate, foreign risks have been cited as the reason for the cut.
A potentially more troubling development, which best symbolizes these foreign risks, occurred shortly after the Fed decision (which made writing this commentary frustrating, given how fast things were changing). US President Donald Trump reignited the China-US trade dispute with fresh tariffs and a currency manipulator label.
Many had pushed trade fears aside and the consensus on the street was that the two sides were close enough to a deal that it wasn’t worth worrying about. But Trump’s latest moves are taking us down a new and darker path. The more time that passes without a resolution to this dangerous trade dispute, the higher the odds of a global recession. We appear to have reached a point in which neither side can back down or show weakness.
As global growth concerns linger, bond yields should continue to fall and the odds of future rate cuts should increase. Europe already has over US$10-trillion of negative yielding bonds, which pushes investors towards dividend yielding defensive equities and real assets, such as gold, as a store of value.
The aim of the Fed’s rate cut was to both lower the US dollar and steepen the yield curve. If successful in this plan, markets could be setup to extend their record run even further. We are still in the middle of reporting second quarter earnings, but so far, the numbers have been better than feared. Earnings should grow around 2% for the year, which will alleviate fears of an earnings recession. The quality of the earnings has been questioned as buybacks have accounted for a higher-than-usual percentage of the growth. But guidance has shown that most sectors were able to survive the first phase of the trade war.
As the trade war persists, we could be setting up for some significant change in sector leadership. If the Fed is successful in steepening the yield curve, it may be the time for the banks and financials to shine. The FANG trade looks increasingly tired and the threat of government anti-trust action could lead to a switch from internet stocks to financials. Apple may also become a target in this dispute and suffer in its second largest market. A move away from technology leadership to defensives and financials could be in the cards.
In what many are speculating was the plan all along, prolonging the trade war only increases the odds of the 100-basis point cut in rates that Trump has been calling for. The tricky prospect for investors is that we are always only one tweet away from fixing it all (or creating even more confusion). Predicting the timing and outcome of this trade dispute will be the key variable in the path forward for equities. Volatility has made a return and may be here to stay for a while. The new normal could be riskier, but also provide opportunities to add value through active management.
Ideas with Purpose
Purpose Gold Bullion Fund (KILO)
Gold continues trade at five-year highs, holding above key technical support levels. Worries about the effectiveness of loose monetary policy and the concerns around global growth and trade are helping keep the precious metal in favour. Purpose Gold Bullion Fund is the no-brainer way to hold physical gold with low fees and the safety of custody with the Royal Canadian Mint.
Volatility has increased as of late, leading to some fairly sharp swings in both equities and bonds. Purpose Tactical Asset Allocation Fund quickly rotates between index-based equity and bond ETFs to adjust to changing market conditions and has proven itself a very effective tool at creating a smoother investment experience. The Fund makes for a great addition for those prone to worrying about market volatility.
— Greg Taylor, CFA is the Chief Investment Officer of Purpose Investments
All data sourced from Bloomberg unless otherwise noted.
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