To my clients:
First, a quick note to clients that next Thursday and Friday I will be taking the second of my intended two long weekend family trips this summer. There will be no update next week. As always, I will be connected while away, and Brenda will be here to accommodate any pressing client needs.
It was a down week for North American stock markets with the Canadian TSX falling 1.6%; the U.S. Dow Jones Index falling 2.6%; and the U.S. S&P 500 falling 3.1%.
Interestingly, in the internal daily package I review every morning, the Portfolio Advisory Group of RBC noted that “all eyes” were on the U.S. Employment Report this morning. Clients will know that I never fail to mention the monthly U.S. Employment Report in these weekly updates, so I would typically agree with this assessment. However, while the jobs report is always a noteworthy economic release (and I’ll of course be commenting upon it later in this missive), this time around I’ll have to respectfully disagree with my colleagues. I think instead that all eyes were firmly fixed on the rearview mirror, trying to make sense of developments over the preceding 48 hours.
Let’s start with the U.S. Federal Reserve rate announcement. As was conspicuously telegraphed by the Fed, rates were indeed cut for the first time in 10 years. Ostensibly the Fed cited trade tensions and lower than targeted inflation as the rationales for the cut, otherwise noting that the U.S. economy continued to do well. But the magnitude of the 0.25% cut was disappointing to some observers who were expecting (hoping?) for a larger 0.50% cut, and the markets turned modestly lower as a result. In the press conference that immediately followed the announcement, Chairman Jerome Powell suggested that this was a “mid-cycle adjustment to policy” rather than the start of a prolonged (emphasis is Nick’s) easing campaign. As is my habit, I had a live chart of the market indices on my computer screen while watching the press conference, and immediately the markets took a sharp turn for the worse as Mr. Powell uttered these words. Apparently the interpretation was that this might be a “one-and-done” rate cut event (at least that’s what the talking heads on CNBC were suggesting) and that, if so, it was not nearly enough to offset simmering trade tensions with China. Well, perhaps I’m just in a disagreeable mood today, but I didn’t see it that way at all. Powell made mention several times (and indeed the Policy Statement itself stated) that the Fed would continue to monitor data, including global trade data, in determining the path of future rate adjustments. It seemed apparent to me that the door to future rate cuts remained open. Further, when the Fed embarks upon prolonged cutting cycles, these cycles are always undertaken to combat recession. The Fed does not see recession looming (Powell explicitly stated this), and as clients well know, nor do I or RBC. Our view remains that we are in a slowdown period for economic growth, especially when compared to the tax-cut fueled and unsustainable growth rates of 2018, and this slowdown period should be worked through in due course. So why shouldn’t Powell suggest that a prolonged rate cutting cycle was off the table? Had he not done so, I’d suggest that the same talking heads would then start fretting that the Fed was signaling recession. Apparently I’m in the minority, but I felt his comments were on point and were being parsed excessively (even more than is usual for these events). For what it is worth, I fully expect another 0.25% insurance rate cut when the Fed next meets in September.
Now let’s move to the topic of U.S./China trade tensions, which were at a simmer heading into the Fed Policy announcement on Wednesday, but which Trump turned up to a light boil yesterday with his tweets indicating he’d impose a 10% U.S. tariff on all Chinese goods entering the U.S. not already covered under the existing 25% tariffs. Beginning September 1st, RBC estimates this 10% tariff will impact an additional $265 billion in Chinese imports. Clearly the in-person trade negotiations that resumed earlier in the week in Shanghai did not go as well as hoped (the fact that the last of these meetings ended about half an hour earlier than expected may have been a clue that this was the case). It should be noted also that the newly suggested tariffs will directly impact consumer goods (like iPhones for example) which had largely been spared under the existing 25% tariff that is focused more upon industrial inputs. RBC Economics’ back of the envelope math suggests a minimal direct hit to GDP of about 0.1%, and went on to note that “the latest tariff threat still doesn’t look large enough to turn ‘tariff man’ into ‘recession man’”. That being said, the proposed tariffs will continue to weigh on business sentiment and dampen consumer confidence, especially since the new tariffs will target consumer goods. In other words, the negative feedback loop from these developments could cut into GDP more than the 0.1% direct hit calculated by RBC Economics.
My bottom-line assessment of the Wednesday and Thursday developments is that a) the Fed acted as expected (by me at least), and any market declines tied directly to the Fed announcement likely owed to that subset of investors who were expecting an immediate and larger 0.50% rate cut, rather than waiting until September when I suspect – see above – that another 0.25% will be forthcoming; and b) Trump’s tariff threat is concerning, but fully consistent with his blustery and confrontational negotiating style… I still expect a deal to be struck before the 2020 Presidential elections although, as indicated in more recent updates, my confidence is diminishing. I’m still not prepared to make portfolio adjustments to offset the risk of a no-deal outcome, although it continues to be an active consideration.
As a last thought on the Fed, Trump and China, it’s interesting to note that President Trump has actively disparaged Jerome Powell’s performance as Fed Chairman, and continues to call for larger and more immediate rate cuts. So, when the Fed cites trade concerns and cuts rates as a result (although not as much as Trump would have liked), can it be considered entirely coincidental that Trump escalates trade tensions even more the very next day? Might this be his ploy to ensure further cuts are forthcoming? Or, looked at from a different perspective, might the Fed rate cut have given Trump the necessary cover to further ratchet pressure against China? I suspect both of these perspectives are in play.
To wrap up this longer than usual update, indeed the monthly U.S. Employment Report was released this morning, and at a 164,000 new jobs created for the month of July, the report exactly matched the expectation of economists. While the 164,000 new jobs marks a decline from the prior month’s initially reported 224,000 new jobs (revised down to 194,000 this morning), it nonetheless represents a solidly decent result for this stage of the economic cycle – especially when the unemployment rate sits at a meagre 3.7%. Also on the labor front, weekly jobless claims stayed near multigenerational lows at 215,000. As repeatedly noted since the yield curve recently inverted, the trend in weekly jobless claims (RBC’s second favourite recessionary indicator) does NOT portend imminent recession. In fact, outside of the yield curve itself, nor do any of the other major recessionary indicators we track. As such, portfolio positioning will continue to favour our conservative mix of dividend-paying equities.
That’s it for this week. Have a fantastic long weekend. The next update will be in two weeks. All the best,
Nick Scholte, CIM, FCSI
Vice-President & Portfolio Manager
RBC Dominion Securities Inc. │ Tel: 604.257.7569 │ Fax: 604.235.9950
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