For The Equity Markets To Keep Rallying, This Has To Happen...

The last few days have seen the re-emergence of the Nike market - just buy it... buy the rumor, buy the news, buy the good news, buy the bad news. As long as Powell keeps his promises, everything will be awesome and stocks will go to the moon Alice.

With markets now pricing in at least three rate-cuts and expectations for a July cut surging to over 80%, belief in a pre-emptive "insurance" cut is now consensus - and The Fed had better not disappoint.

However, as Bloomberg's Ye Xie warns, while, historically, preemptive Fed rate cuts have tended to boost the stock market, this time may be different.

Any student of stock market history would tell you that the Fed’s "insurance" cuts in 1995-1996 and 1998 did extend the bull market and economic expansion.

What’s different this time is that the front-end of the yield curve is much more deeply inverted than in the 1990s. In other words, markets have more aggressively discounted policy easing. With Fed fund futures pricing in about 70 basis points of cuts by year-end, the FOMC has a high bar to keep equity investors happy without fomenting recession fears

Xie continues:

  • While investors have priced in a fair amount of good news in terms of lower interest rates, they’re yet to factor in enough of the bad news on global trade. Historically, S&P’s EPS estimates track global trade volume fairly closely.

  • Analysts are expecting earnings to grow a little less than 5%. Based on regression, that would require trade to increase 2% to 3% this year after, contracting 1% in 2018. That seems optimistic as exports from open economies, such as South Korea and Taiwan, continue to shrink.

  • Sure, President Trump dropped plans for tariffs on Mexican exports Friday night, a moved welcomed by his own Republican party. But the trade war against China is a different story because it has bipartisan support. The standoff between the world’s two largest economies shows no signs of easing.

To sum up, for the equity market to keep rallying, the Fed has to cut rates quickly and decisively, the trade war needs to be resolved, the economy needs to keep humming, and global trade needs to pick up.

How do you like those odds?