On the one hand the market looks very healthy (new all-time highs every day), but if you look more deeply there are some signs of dysfunction that appear as though they may spill out into the biggest indexes. Demand for risk assets looks quite weak. Consider for instance that the Russell 2000 is hurting even as large caps rise. Similarly, junk bonds are not doing well despite the seeming risk-on environment. Both of those developments show that liquidity is lacking. “Small caps are more sensitive to liquidity issues, both good and bad”, says a market strategist.
FINSUM: The weakness is small caps and junk bonds shows that more investors are sitting on the sidelines right now, but that does not necessarily mean trouble more broadly.
The Fed has historically been the level-headed kid at the party, always trying to calm things down when they got out of hand. But that appears to no longer be the case, as Powell surprised even the most dovish investors with his very soft statements last week. What comes next may shock markets—some think the Fed will make a rare 50 bp cut in their July meeting. How the market would react is anyone’s guess (likely positive initially). “Historically the Fed has wanted shock and awe when they ease”, says the CIO of Northwestern Mutual Wealth Management.
FINSUM: The Fed seems like it wants to go big, despite the fact that unemployment is at record low levels and prices are stable. The central bank clearly wants to keep the bull market rolling.
Goldman Sachs thinks the Dollar might be in a for big surprise. On top of his grumbling about the Fed not lowering rates quickly enough, President Trump has been tweeting about the unfair advantage that other countries have in lowering their value against the Dollar. Trump apparently wants a weak Dollar to help the US compete more effectively in the global economy. Accordingly, Goldman Sachs think there is a good chance that Trump uses some special tool to intervene and weaken the currency, such as through the Treasury department.
FINSUM: This is not as unprecedented as it sounds. Even Powell has said the Treasury is the traditional power in charge of exchange rate policy. This would likely have a big impact on markets.
Jerome Powell’s performance could not have been much better. He gave exactly what the people wanted—dovishness. In fact, if anything, he was almost comically dovish, disregarding the very strong jobs performance last month. No matter though, investors are pleased as it now looks nearly 100% likely the Fed will cut rates later this month, and seems as though they will stay on a cutting path for some time. The Fed’s shift in policy appears to affirm that they are currently considering the condition of the global economy as a major threat to the US.
FINSUM: The Fed is in a pretty easy spot if you think about it. Inflation is very low, markets want cuts, and the global economy is looking weak. Simple solution with no real downside—cut rates.
Investors likely already know that low cost index funds tend to greatly outperform high fee actively managed funds (to the tune of 1.5% or more annually). That comes as no surprise. However, what was surprising to us is that in fixed income, the tables are greatly turned. While passive funds do have a slight edge over active ones on average (0.18% per year), in many cases high fee actively managed fixed income funds outperform passive ones. This holds true over long time periods, including ten-year horizons.
FINSUM: This is an interesting finding and one that makes intuitive sense. The bond market is vast, hard to access, and full of intricacies. That kind of environment lends itself to specialism in a way that large cap equities does not, and the performance metrics show it.
The yield curve inversion has largely faded from headlines. Things that become the status quo often do! But in that development lays a hidden but worrying truth—the longer the yield curve is inverted, the more likely it is that there will be a recession. The inversion has been in place for over a month now and it is actually getting worse, with long-term yields continuing to drop. A yield curve inversion has proceeded every US recession in the last 50 years.
FINSUM: If the Fed proceeds with cuts, it seems like the inversion may abate. But then again, the rate cut would be an implicit admission that we are on the way to a recession.