HIGHLIGHTS:
- The S&P 500 closed at a record high.
- Jay Powell’s Jackson Hole speech and what it means.
- Economic reports generally healthy except housing.
- Breakthroughs on trade talks remained elusive.
- The Week Ahead: Personal income, spending and inflation data will close out August.
The S&P 500 closed at a record high.
Via Nova believes that the future course of Fed policy and trade talks are the two biggest fears facing the stock market currently. Powell’s comments eased worries of excessive tightening helping lift stock prices to record highs. However, progress in reducing trade tensions remains elusive and could be an ongoing source of market volatility.
The S&P 500 stock index clinched its longest bull-market run on Friday, closing above its previous January high, as Federal Reserve Chairman Jay Powell affirmed the U.S. central bank’s current gradual pace of rate hikes. The S&P 500 last reached a new closing high on January 26, then retreated more than 10 percent. Friday’s new closing high confirmed that the index’s bull run remained intact. The tech-heavy NASDAQ Composite and the small cap Russell 2000 also closed at record highs.
For the week, the S&P 500 added 0.88% led by strength in consumer discretionary and energy stocks, while the Russell 2000 rose 1.94%. International stocks also increased on the news as did emerging market equities, though both remain in negative territory year to date.
The somewhat dovish tone in Powell’s speech was credited with a modest decline in Treasury bond yields and a 0.27% increase in the Bloomberg Barclays Aggregate Bond Index. In other markets, oil prices rose back close to $70/barrel and gold moved back up over $1,200/ounce. Treasury Inflation Protection Securities (TIPS) also gained on the week.
Jay Powell’s Jackson Hole speech and what it means.
Fed chairman Jay Powell has a very effective and accessible style of communication, and his keynote address at the annual Jackson Hole conference is worth a read. Avoid the media summaries this time and read the actual speech. His comments did not alter expectations that the Federal Open Market Committee (FOMC) will raise rates by another quarter percent at their September meeting, but they did provide some useful and important color on the challenges of implementing monetary policy in the current environment. Powell contends that, in the absence of precision surrounding the monetary policy objectives, a more gradual approach to raising interest rates is the most appropriate strategy. His comments are consistent with Via Nova’s view that the Fed will not raise rates too rapidly and short-circuit the expansion.
Powell offered a useful commentary on the perils of using macroeconomic estimates of key policy objectives like the natural rate of unemployment, the potential economic growth rate and the neutral real interest rate. These concepts are so engrained in conventional economic thinking and research that they have their own special shorthand names: u* (pronounced “u star”) is the natural rate of unemployment, r* (“r star”) is the neutral real rate of interest, and π* (“pi star”) is the inflation objective. He called this conventional wisdom approach to implementing monetary policy as “navigating by the stars.” “Navigating by the stars can sound straightforward. Guiding policy by the stars in practice, however, has been quite challenging of late because our best assessments of the location of the stars have been changing significantly,” according to Powell.
Powell then went on to defend the FOMC’s current practice of careful analysis of multiple factors in setting policy. The Fed’s research shows that “no single, simple approach to monetary policy is likely to be appropriate across a broad range of plausible scenarios.”
In the current environment, Powell emphasized the need for continuing the gradual interest rate increases going forward. “While the unemployment rate is below the Committee’s estimate of the longer-run natural rate, estimates of this rate are quite uncertain. The same is true of estimates of the neutral interest rate.”
Economic reports generally healthy except housing.
The week’s economic reports were generally strong and point to continued above-trend growth in the third quarter. The Atlanta Fed’s latest reading on third quarter GDP growth increased to 4.6%. Capital goods orders rose more than expected in July, and initial jobless claims fell to a near historic low reinforcing evidence of a strong economy. Home sales were the soft spot in an otherwise solid week of economic data, with both new and existing home sales falling short of estimates. The sluggish growth in the housing market this cycle has been blamed on a number of factors including low inventories of homes for sale, higher mortgage rates, increased builder expenses related to state and local government requirements, higher costs for labor related to the tight job market and increased materials costs related to recent trade tariffs such as on lumber.
Breakthroughs on trade talks remained elusive.
Two days of trade talks between the U.S. and China failed to produce any visible sign of progress, reducing the prospects of a near-term deal. It is notable that there was no discussion of follow-up talks or any accomplishments. Earlier, expectations were high that the two sides would agree on a framework that would be addressed at a U.S. China summit in November. The lack of progress poured cold water on those hopes.
Via Nova believes both sides are interested in reaching a deal, and that neither side wants an all-out trade war. However, we also believe that progress on tariff reductions is historically very slow. This suggests to us that trade tensions could remain a cloud over an other wise positive outlook. Any signs that tensions are easing would likely be positive for stocks.
The Week Ahead: Personal income, spending and inflation data will close out August.
Personal income and spending are expected to show further gains in the report due Thursday, pointing to healthy consumer spending and a strong economy. However, more attention may be paid to the Fed’s preferred inflation gauge, the personal consumption expenditures deflator (PCE deflator), which accompanies the personal income and spending data. The Fed agrees and acknowledges that consumer spending is strong, but there is more potential uncertainty surrounding the outlook for inflation, which has been surprisingly low so far this cycle. Inflation, as measured by this index, increased to 2.3% year-over-year in July according to forecasts, up from 2.2% in June. However, core inflation is likely to remain below the Fed’s 2% longer term inflation target.