Stocktake: Markets may have driven Powell’s policy U-turn

Trump cheers Dow 25,000 – again, and the ‘Venezuelan’ wealth tax

  Federal Reserve chairman Jerome Powell turned unexpectedly dovish after markets soared last week. Photograph: Reuters

Federal Reserve chairman Jerome Powell turned unexpectedly dovish after markets soared last week. Photograph: Reuters

 

Markets soared last week after Federal Reserve chief Jerome Powell turned unexpectedly dovish, performing a policy U-turn that had analysts everywhere asking: why? In December, the Fed made clear that more rate hikes were likely and it wanted to normalise policy by continuously shrinking its multitrillion dollar balance sheet on “automatic pilot”. That balance sheet runoff “has been a good decision,” said Powell, “and I don’t see us changing that”.

Six weeks later, the autopilot is gone. As for rates, many now believe the rate-hiking cycle is over and the next move will be down, not up. Powell explained the U-turn by referring to “cross-currents” like slower growth in China and Europe, tightening financial conditions, trade tensions and the risks of a hard Brexit, although analysts note many of these “cross-currents” were also evident in December.

Since becoming Fed chief 13 months ago, Powell has played tough. The impression given was that market swings would not knock the Fed off course, an impression that led to US stocks falling on each of the first seven rate decision days since Powell took charge. That has changed, with last week’s meeting strongly suggesting the Fed was “capitulating to recent market volatility”, as Barclays put it. Weaning the markets off stimulus is, said Allianz economist Mohamed El-Erian, “proving a lot trickier” than expected.

Earnings: bad, but not terrible

Shares in Apple popped higher last week after the company reported earnings. It’s not that Apple’s results were great – the company lowered expectations only weeks earlier – so this was just investors breathing a sigh of relief that things were bad, but not terrible.

That reaction has been common during the current quarter. According to FactSet, companies that lag estimates ordinarily fall an average of 2.6 per cent in the four-day period around earnings. Not this time. Laggards have actually enjoyed small gains. Sceptics might see this trend as unsustainable, given the darkening earnings outlook. Earnings soared 20 per cent in 2018 but lowered estimates mean analysts now expect growth of less than 1 per cent in the first quarter. Expectations for the second and third quarters are similarly underwhelming.

Recent market reaction might seem counterintuitive, but it’s no aberration. Ned Davis Research data shows very strong earnings – in excess of 20 per cent growth – have historically been associated with the poorest stock returns. In contrast, stocks tend to do well when earnings are mediocre. Markets look forward, not backwards. Stocks did poorly in 2018, even though earnings were surging. Right now, the opposite is the case – earnings aren’t great but stocks are just fine.

Stocks are still ‘under-owned’

Global stocks enjoyed their best January on record and their best month in over three years but the mood remain cautious. In the US, the latest consumer confidence survey shows the percentage of consumers who are bullish is at its lowest level since July 2016, while bearishness is at six-year highs. The last time the bull:bear spread was this wide was near the major market bottom in early 2016, Bespoke Investment noted last week.

The latest American Association of Individual Investors (AAII) poll shows bullishness remains well below average levels. Meanwhile, fund flows remain negative, Barclays noted last week.

Despite the big market rally, investor positioning “has not changed much” and remains “cautious”, with funds reallocating “further away from equities into bonds and cash” and sector positioning “still skewed to defensive”. All of this suggests stocks still have room to keep rallying; equities are “not oversold anymore”, says Barclays, but they’re still under-owned.

Trump cheers Dow 25,000 – again

“Dow just broke 25,000”, Donald Trump tweeted last week. “Tremendous news!” Is it? Trump first tweeted about Dow 25,000 over a year ago (“Dow just crashes through 25,000. Congrats!”). Stocks then tanked and did not see 25,000 again until July. “The Stock Market hit 25,000 yesterday”, he tweeted at the time. “It is all happening!” Trump’s obsession with Dow 25,000 is odd. “This has to be dementia or some other type of cognitive decline”, tweeted pseudonymous financial blogger Invictus. “Who would brag about the market retaking a level it hit ~13 months ago?” 

Hedge funds and the ‘Venezuelan’ wealth tax

Not everyone is keen on Democratic presidential hopeful Elizabeth Warren’s proposal for an annual 2 per cent wealth tax on household assets in excess of $50 million. A “Venezuelan” idea, said billionaire and former New York mayor Michael Bloomberg. Kyle Pomerleau, an economist at the Washington-based Tax Foundation, was similarly unimpressed. A 2 per cent wealth tax is a large tax, he tweeted, asking people to consider if they would ever put their money into a managed fund that charged a 2 per cent annual management fee.

Indeed, replied French economist Gabriel Zucman: “Ask people with hundreds of million of dollars if they would put their money in a mutual fund that charged a 2 per cent annual maintenance fee, and 20 per cent on income. Oh, wait.” Indeed. Who needs Venezuelan wealth taxes when you’ve got hedge funds?

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