This week, all eyes will be on the Federal Reserve’s Federal Open Market Committee (FOMC) meeting on Wednesday. Ahead of this, Morgan Stanley (MS, Financial) released the latest edition of its Business Conditions Index, which showed one of the worst prints of all time, as well as an accompanying research note.
Dire sentiment prevails
Amid the continuing U.S.-China trade tensions, and some weak economic data, many investors are hoping that the Fed will bail them out with a rate cute. Only time will tell whether they will do so; however, what we do know is that bad data has continued to come out:
“The economy and earnings are slowing more than most investors think. More specifically, freight shipments, oil demand, capital spending have all been weaker than expected during the second quarter. While retail sales bounced back in May, many retail companies reported weaker earnings due to cost pressures and bloated inventories, which we think are likely to weigh on growth in the second half of the year.
Most worrying, however, was the release of our proprietary Business Conditions Index for June last week. This report is an amalgamation of our industry analysts views of the state of things at the companies that they cover. Not only was this release weak, but it was the second-lowest reading on record, and the single biggest monthly drop.”
The acute deterioration in business sentiment is of great importance as it feeds into managers’ spending decisions, and explains why capex has been weakening this year. Moreover, the report points to weakening employment data as further evidence of a coming slowdown. Meanwhile, earnings estimates still look elevated.
“Of course, the Fed will respond if payrolls start to shrink, but history suggests that it will take some time for the market to come to terms with the Fed cutting growth is going negative, as opposed to just slowing ... While the Fed is closer to cutting interest rates and earnings are likely to deteriorate again during second-quarter reporting season, we are getting closer to recommending rotation back to more cyclical areas of the stock market, but not yet.
We’re waiting for growth expectations to come down to more realistic levels, or the Fed to get ahead of the market with rate cuts. Two things will tell us it’s time. One, valuations come back to absolutely cheap levels, about 10% below current prices, or two, the yield curve steepens materially. Until then, stay defensively orientated in your portfolios.”
The crux of the issue is that the economy never got a chance to go through a proper rate hike cycle for the Fed to start cutting rates now. If the new normal is that rates stay permanently low and are never allowed to rise again, then the consequences could be dire. The last decade has been an unprecedented experiment in monetary policy, and we appear to be sailing further and further into uncharted waters with every passing year.
Disclosure: The author owns no stocks mentioned.
Read more here:Ă‚
David Einhorn: How to Manage Investment RiskÂ
3 Pieces of Investment Advice From Seth KlarmanÂ
Not a Premium Member of GuruFocus? Sign up for a free 7-day trial here.
