Key Points

  • Ongoing battles, including trade, Fed vs market, Fed vs politicians, slowdown vs. recession, bonds vs. stocks, and bulls vs. bears may continue to drive volatility.

  • Recession risk is rising, but keeping it at bay could mean rate cut(s) lead to a stronger stock market based on history.

  • Leading indicators’ rate of change rolled over last September, suggesting slower growth ahead.

As we look ahead to this year’s second half, we need to assess the stage and impact of myriad battles underway: the United States vs. China, the market vs. the Federal Reserve, President Trump vs the Fed, recession vs. slowdown, and the stock market vs. the bond market.

Will Fed take out “insurance policy” due to trade war?

I started in this business 33 years ago, working for the late-great Marty Zweig. He was well-known for myriad research innovations and prognostications; but paramount among them might be his coining of the phrase, “Don’t fight the Fed.” Even Marty would concede it’s never as simple as that when it comes to market behavior and monetary policy, but the notion is worth considering as we exit this year’s first half and look ahead to the second half.

I often wonder what Marty would be thinking today; with the market’s perspective on the path for interest rates representing a still-wide gap relative to the Fed’s own expectations. Perhaps a more apt phrase this time is, “Hey Fed, don’t fight the market.” Will the Fed opt to fight political pressure? Or will the Fed opt to take out an “insurance policy” to combat the prospective hit to the economy from the ongoing trade war between the United States and China? Regardless of when the Fed opts to begin cutting rates, we are currently in the longest stretch in at least 50 years without a rate cut.

The June Federal Open Market Committee (FOMC) meeting gave markets what they were expecting; which was no change to rates, but the removal of the key word “patient” in the statement, and firmly putting a July rate cut on the table. Ultimately, if the Fed cuts rates in July or some other meeting(s) in the second half of the year, the action by the stock market in the subsequent period will likely rest on whether we are heading into an economic recession.

As you can see in the chart below, initial rate cuts when no recession was underway or imminent were historically accompanied by stronger stock market performance over the subsequent year relative to recession periods. For those of you surprised that the path for stocks around recession periods was lower but still up, notice there was typically weakness leading into the initial rate cut (in keeping with the leading nature of the stock market).

Recessions Matter

DJIA First Fed Rate Cut

Source: Charles Schwab, Ned Davis Research (NDR), Inc. (Further distribution prohibited without prior permission. Copyright 2019© Ned Davis Research, Inc. All rights reserved.). May 5, 1920-September 18, 2008. DJIA=Dow Jones Industrial Average. Recession cases: 1921, 1924, 1926, 1927, 1929, 1932, 1954, 1957, 1960, 1970, 1974, 1980, 1981, 2001, 2007. No recession cases: 1933, 1967, 1968, 1971, 1984, 1989, 1995, 1998.

Unless there is a noticeable deterioration in economic data between now and the end of July, when the FOMC next meets, a rate cut would likely be characterized as an “insurance cut,” to combat prospective economic weakness from the trade war (assuming a comprehensive trade deal isn’t reached in/around the G20 meeting). Still-low inflation would also likely be pointed to as a rationale for lower rates.