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What Did We See?

• The US equity markets rallied again in July.
• The Federal Reserve stepped in with a shift towards cutting rates and followed through with a 0.25% interest rate cut.
• The temperament of the markets have shifted to a Fed fueled rally.
• Global markets were mixed with Emerging Markets and Asia (ex-Japan) turning negative.
• The UK, Japan and Europe were positive.

Where Do We Stand?

• The Fed is now walking on the thinnest of tightropes as it navigates maintaining the economic expansion.
• We continue to monitor the recession story very closely but still don’t believe one is imminent.
• We continue to de-risk our client portfolios as opportunities to do so present themselves but no wholesale changes are imminent.
• While the markets have not been acting “normal” the returns to investors have been great.
• We continue to rebalance your accounts accordingly.

“Summer loving had me a blast. Summer loving happened so fast”

The market caught the flu in December of last year and a summer cold in May of this year. So, this month the Fed decided it was going to inoculate the markets from the dreaded Fall swoon.

By some measures, the economic immune system is fragile. Outside the US, the world has been struggling with slowing growth, especially in Europe where indicators on manufacturing health have been flashing red. This weakness gave the Fed enough cover to move forward on a rate cut that the White House has been pining for for several months.

The Fed to the rescue?

This is just the 5th time in the past 25 years that the Fed has moved from raising rates to cutting rates. All 4 prior times have included more than one, or a series, of cuts. So, if recent history is our guide, this is the beginning of a rate cut cycle. Albeit likely a small one. In 1995 and 1998 The Fed cut rates over a series of three small reductions. The result was an avoidance of an economic downturn in the near term. So they thought they did the right thing. The other two times the Fed shifted to cutting rates was in 2001 and 2007. These cuts were in response to burgeoning economic recessions at the time. Both times didn’t work. We still got a recession in 2001 and 2007.

Many are criticizing the Fed for purportedly caving under pressure from the White House. Technically, global growth has certainly slowed, the trade war is ongoing and inflation remains very low. In a vacuum, these are reason enough for a “maintenance cut” (a maintenance cut is a reduction in interest rates in an effort to prolong an economic expansion as opposed to a “required cut” which would be in response to some economic shock or ongoing economic weakness). However, when you look at the current health of the US economy today this interest rate cut becomes a bit of a chin-scratcher.

History as our guide

Let’s focus on the two “maintenance cut” periods of 1995 and 1998. In 1995 they started with interest rates at 6% and moved it down to 5.25% over three cuts. In 1998 they moved from 5.5% to 4.75% over three cuts. Then, in 1999 the economy began to overheat and they raised rates all the way back up to 6.5%. This left enough fuel in the rate cutting machine to stave off a terrible recession when the dot-com bubble burst. They were able to move all the way down to 1% and fuel the recovery (i.e.: next bubble) that led to the housing crash. Because of this the recession was short in 2001 and the economy recovered out to 2008. Thus, before the housing crash they were able to get rates back up to 5.25%.

Today is different

Today we have a very strong economy with rates at 2.5% (2.25% after this most recent cut). Let’s assume we are in a similar pattern to the 1995 and 1998 periods. So, rates will potentially drop to 1.75% (maybe only two cuts to 2%?) during this rate cut cycle. Let’s further assume this actually works and the global economy begins to act (and party) like it’s 1999. (Thank you, Prince!) After their maintenance cuts and from mid-1999 to mid-2000 the Fed was able to raise rates by a total of 1.75% before the bubble burst and they were then forced to cut rates. So we could likely go from 1.75% to 3.5% before the bubble of 2020 (or 2021 or 2022…) bursts. No recession since 1958 has begun with rates so low. This is an experiment I wish we were not trying.

Furthermore, in the absence of spending cuts on Capitol Hill we get these Fed interest rate cuts. In fact, the debt ceiling was just raised again! So one can expect spending to continue to climb. The good news there is that the US government’s effect upon the economy is now a bit more muted through the 2020 elections. The bad news is that the Federal Reserve can’t cut our way out of a spending problem. And when the spending inevitably ends the cracks in the economy will become more evident. But that is a problem for another day (sound familiar?).

The thinnest of tightropes

What does this all mean? It means the Fed is walking on the thinnest of tightropes. Cutting rates from 3.5% to zero in the face of an economic slowdown or recession is a lot different than cutting from 5.25% to zero (2008) or 6.5% to 1% (2001). Sure, there is the new solution of quantitative easing (injecting liquidity into the system) to make up the difference but at some point the hen will come to roost. We are seeing this today with Europe’s experiment with negative interest rates. What was supposed to be a temporary negative rate environment there has transformed into 5 years of negative rates. The result has not been economic growth as expected. The result has been weaker banks, punished savers, zombie companies staying alive and an unsustainable surge in asset prices and corporate debt. Not ideal and not where we want to be.

Where do we stand at Shorepine Wealth Management?

In the interim there is no reason to fight The Fed. Everything has rallied in 2019. I mean everything. Through July, the S&P 500 is up around 20%. Europe is up about 18%. The UK is up over 15%. Asia is up over 9%. Emerging Markets are up over 9% and Japan is up over 6%. Bond markets are up significantly as well because yields have moved down. REITS are up. Commodities are up. Even Bitcoin is up. In a normal market many of these things do not move in tandem. Stocks usually go up when bonds go down and vice versa. This is not a normal market. It’s great for investor returns but not normal.

Taking the ride

As we have talked about in prior updates, we have been de-risking our portfolios but not making any wholesale changes to our client’s allocations. Neither will we be making any wholesale exits from a market that is working. However, we are ever cognizant of the risks cited above and know that preservation of capital is paramount in what we do. Please email me or call me to discuss your own personal situation.

Lastly, we all know that “Summer fling don’t mean a thing but oh oh the summer nights…” but we also know that summer’s don’t last.

If you have any questions or have experienced any changes in your financial situation please do not hesitate to Contact Me.

We appreciate your being a part of the Shorepine Wealth Management family and wish you all the best!

Investment Products are Not FDIC Insured. No Bank Guarantee. May Lose Value. Investing involves risk. All written content on this website is for information purposes only. Opinions expressed herein are solely those of Shorepine Wealth Management, unless otherwise specifically cited. This is neither a solicitation of offers to buy securities nor an offer to sell securities. Past performance is no guarantee of future results. Material shown here is believed to be from reliable sources however, no representations are made by our firm as to another parties’ accuracy or completeness. All information or ideas provided should be discussed in detail with an advisor, accountant or legal counsel prior to implementation. Shorepine Wealth Management, LLC is a registered investment adviser offering advisory services in the State of California and in other jurisdictions where registered or exempted.