It’s been touted over the last month and a half that there are two main problems hanging over the market (supposedly holding us back from continuing one of the longest bull markets in history). The first is rising interest rates and the second is the trade war with China.
The data coming from homebuilders and auto dealers has been relatively stark. A median home in the United States is roughly $300K. That means a 1% rise in interest rates will cost an extra $300/month for a mortgage (if the Federal Reserve raises rates in December it will have raised by 1% this year). That will put affordability out of range for some potential buyers. This could lead to a “resetting” of asset prices throughout the economy, just as the converse (lowering interest rates) caused asset prices to inflate. During his speech today, Fed Chairman Jay Powell made it clear that the “neutral” rate is very close to where it is right now, which signaled to the marketplace that a pause in rate hikes is around the corner. This is exactly what the market wanted. Some signal that the deliberate deflating of asset prices was going to be gradual and that the Fed is aware of the “two steps forward, one step back” approach in order to prevent destabilization of the economy.
The rhetoric surrounding China, tariffs, and the G-20 summit (Friday) could lead to another market upside surprise, if talks with President Xi are positive. I could envision a scenario that would lead to another 5%-10% move in US equity markets (and even more in emerging markets).
The real question to me will be what happens if both of these headwinds are mitigated? Will the market zoom back to all-time highs? Given the growth numbers and cutting of guidance throughout the Q3 earnings seasons, I find that scenario to be highly doubtful, but not out of the realm of possibility. The takeaway from today should be to survey the overall landscape and keep our heads on a swivel. In my opinion, the speed and magnitude of October’s decline was a clear sign that something is different. Chairman Powell’s comments don’t change the fact that even after today’s stellar rally, the technology sector (XLK) is still 12% below it’s all-time high, made just 8 weeks ago.