To my clients:

It was a mixed week for North American stock markets with the Canadian TSX finishing up 0.8%; the U.S. Dow Jones Index finishing down 0.2%; and the U.S. S&P 500 down 0.1%.

After a three week hiatus owing to holiday, my weekly updates return. While this week saw mixed results for North American markets, the overall returns for the month of August we positive.

Rather than cover off all that has transpired over the past several weeks, I’m going to instead limit my comments to the following three highlights as I see them: 1) Q2 Corporate Earning Results; 2) Fed Chair Jerome Powell’s speech at the annual Jackson Hole Economic Policy Symposium; and 3) the erosion of independence at the Fed and other important agencies and institutions.

1. Corporate Earnings have been excellent. 81% of S&P 500 companies reported upside surprises to their Q2 earnings with an average “beat” of 7.7%. Moreover, 100% of the so-called Magnificent 7 predominantly tech companies [Alphabet (aka Google), Apple, Amazon, Microsoft, Meta (aka Facebook), Tesla and Nvidia) reported earnings beats. Analysts expected these companies to grow their earnings at an average rate of 13.9%. Instead, the Mag 7 grew their average earnings at a stellar 26.6%! As I’ve repeatedly said in recent months, the economic engine that is corporate America is a powerful and resilient marvel. Its ability to withstand all manner of shocks and to power the U.S. economy forward (and avoid recession) is extraordinary. A business cycle which in past decades might have seen a recession every 4 years or so, has now been stretched to seeing recession perhaps once per decade. The stretch of the business cycle likely owes to the ever increasing sophistication of both business managements and macro policy setters (more on this in point #3).

2. Federal Reserve Chairman Jerome Powell said this at the annual Jackson Hole Symposium last week: “Risks to inflation are tilted to the upside, and risks to employment are to the downside – a challenging situation… [The Fed will] proceed carefully, but the shifting balance of risks may warrant adjusting our policy stance.” These remarks signaled that the Fed is likely to prioritize help for the recently weakening labor market over inflation concerns. In other words, rate cuts are on the table at the next Fed policy meeting on September 17th, and the markets immediately shot up about 2%.

3. Fed (and other agencies) Independence Teeters. As most will know, President Trump has been waging a campaign for the Fed to lower interest rates and/or have Chair Jerome Powell resign (Trump previously threatened to fire Powell but subsequently backed away from that threat as a) there was no legal basis to do so; and b) markets were reacting negatively to the threat). To date, the Fed has not lowered rates nor has Powell resigned. Now it appears Trump (and his enablers – notably Bill Pulte) are taking a different tack by attempting to fire Fed Governor Lisa Cook “for cause” over allegations of mortgage fraud. While the intent to remove a Biden appointee from the voting Fed board and replace her with a Trump loyalist is blatantly obvious, the alleged facts (not yet proven) of the case might in fact see Trump succeed in his attempt. I won’t dig into the merits of the case itself, but I’ll just reiterate that it seems possible. This is important because if Cook is removed and replaced with a Trump loyalist inclined to cut rates, then the balance of power on the voting Fed board likely shifts to those favoring rate cuts. However, I do wonder why Trump would take this step. Jerome Powell already signaled that the Fed was likely to cut rates in September and Trump’s tactics seem counterproductive to the Administration’s goals.

But beyond the mere tactics of the moment, the bigger issue is that the Trump Administration is attempting to wrest control of Fed policy from a heretofore independent body. Economists, market strategists and historians are near universal in their opinion that maintaining central bank independence is a critical foundation of any properly functioning market-based national economy. Setting monetary policy for political purposes (as it seems Trump is attempting to do) erases the credibility of the institution. While the Federal Reserve is ultimately accountable to Congress and the public, its operational independence has become a cornerstone of that credibility. The ability to make difficult but necessary decisions, even when they may be unpopular, is what enables the Fed to maintain long-term economic health.

But its not just the Fed. Recall that July’s monthly labor report was very disappointing and there were massive revisions to the prior two month’s data as well. What did Trump do? He fired Erika McEntarfer, the head of the U.S. Bureau of Labor Statistics, the institution responsible for compiling the data. Trump said the data was “rigged”. Whether or not that is possible (and my research suggests that it is not), it should be obvious that the issue here too is the erosion of trust. Can data be trusted if the head of an institution fears his/her job will be threatened if the numbers are contrary to the wishes of the President?

Point #3 is a critical longer-term issue that, in the short term, I suspect will be masked by the ongoing strength of #1 and the likely policy path of the Fed per point #2. Time will tell, but I will absolutely be monitoring developments with respect to Fed independence – because it is important.

That’s it for this week. All the best,

Nick

Nick Scholte, CIM, FCSI

Senior Portfolio Manager
RBC Dominion Securities Inc. │ Tel: 604.257.7569
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