July 10, 2019

Bill Miller 2Q 2019 Market Letter

Sometimes good news is just good news, even if the market doesn’t seem to think so. On July 5th, it was announced that the US economy added 224,000 jobs in the month of June, a big increase over May’s disappointing gain of 72,000 jobs, and much better than the forecast of 160,000. The stock market promptly sold off about 1% before recovering some of those losses by the close. The putative reason for the market’s reaction was that the stronger jobs report meant the Federal Reserve would not cut rates as much as 50 basis points in July as some had hoped, while still retaining a 99% probability of a 25bps cut. The unemployment rate inched higher to 3.7%, due to an increase in the labor force participation rate, which is also good news. Wages continued their solid growth of 3.1%. The US economy has now expanded for the longest period in history. Inflation remains quiescent, corporate profits are at an all-time high, monetary policy remains accommodative in both the US and globally. Fiscal policy is likewise expansionary as we are running the largest deficits in history at this level of unemployment and at this stage of an economic expansion, so far without the widely predicted ill effects.

The more likely reason for the market’s initial negative reaction is the new all-time high of 2995 the S&P 500 hit on July 3rd, coupled with a very strong first half gain of 18.5%. The previous two highs were followed by corrections in the 4th quarter of last year and again in May. It would not be surprising if investors decided to take some money off the table. Trying to guess the twists and turns of the market over the course of a few months is an exercise in futility, which has no impact on the incessant attempts to do just that.

There is other good news. Christine Lagarde, the head of the International Monetary Fund, will become the new head of the European Central Bank. Mark Carney, head of the Bank of England, is the favorite to succeed her at the IMF. Both are excellent choices in my opinion, with Lagarde widely expected to follow the policies of her predecessor Mario Draghi, which won broad acclaim. Back here, President Trump has nominated Judy Shelton and Christopher Waller to the Fed. Shelton is the more unconventional selection and has advocated for a return to the gold standard or some other tie in to commodity prices in order to stabilize the dollar. Waller is the director of research at the St Louis Fed where his boss is James Bullard, who is regarded as one of the more dovish Fed governors and who supported a cut in rates at the June Fed meeting, the only governor to do so. Both nominees seem likely to be confirmed and are expected to be advocates for lower rates for longer.

Lower rates for longer should lead to higher stock prices for longer, as they support a continuation of the record expansion. Stocks generally move in the direction of earnings and those, while slowing, show few signs of reversing. Over the duration of this expansion nominal GDP has grown 50% as has consumer spending, not surprising since consumption makes up over 70% of GDP. It’s more good news that the consumer is in good shape with a solid balance sheet, jobs are plentiful, wages are rising, and the savings rate is very solid at over 6%. A healthy consumer should also underpin continued economic growth and, in turn, the stock market.

The only bad news is the relative absence of bad news. Geopolitics remains unpredictable and could derail the market and the economy. The tariff and trade issues that have bedeviled the market are on hold for now, as negotiations continue. They could always reappear and lead to concerns about how long lasting they will be and their impact on the global economy. A risk that led to the very steep decline in the fourth quarter of 2018 is a Fed that pays more attention to its models than forward-based market indicators. Chairman Powell has, properly, moved away from his remarks that rates remained a long way from neutral and his, and other Fed governors’, recent comments indicate we are at neutral or probably a bit over as almost all global growth data and market sensitive prices show a decided loss of economic momentum. The markets, as of now, are looking for two cuts in the second half, which seems about right given all the evidence. The inverted yield curve remains a worry, but if the Fed begins to ease, as the market expects, that worry should dissipate. Bond spreads have narrowed recently, another bullish indicator for stocks. As Warren Buffett noted at the Berkshire Hathaway annual meeting, stocks are very cheap compared to bonds. The best reaction to Fed rate cuts would be a steadily rising 10-year yield which would signal both expectations of faster growth but also inflation that was headed in the direction of the Fed’s long-held target of 2%. A steepening yield curve would be quite bullish for equities.

The path of least resistance for stocks remains higher.

Bill Miller, CFA

July 7, 2019
S&P 500 2990.41


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