For the week ending September 20
This summary is provided by Bryn Mawr Trust Wealth Management.
Markets Shrugs Off Potential Destabilizing Events
On Saturday, September 14, an attack on Saudi Aramco’s Abqaiq and Khurais facilities cut off roughly half the nation’s oil production in one day. While the oil supply disruption was less severe than originally forecasted, oil prices started last week with an 18% intra-day spike. There was widespread speculation that Iran was responsible for the attack, despite Iranian official claims that the attack on the Saudi oil fields and refineries was launched from Yemen by Houthi rebels. Following the incident, President Trump made a statement that the United States is “locked and loaded,” which resulted in Iranian officials making a threat of “all-out war” if attacked by the United States or Saudi Arabia.
Oil Prices (WTI)
(1-Month Ending 9-20-19)
Source: FactSet, Inc.
Following the incident in Saudi Arabia, overnight repurchase agreement (repo) rates rose sharply in advance of last week’s Federal Open Market Committee (FOMC) meeting. The repo market enables large institutions to obtain short-term funding by pledging high-quality, fixed income securities as collateral. Repo rates surged overnight on Monday (September 16) which prompted the Federal Reserve (Fed) to intervene and supply $200 billion in short-term funding to prevent credit markets from freezing, a scenario reminiscent of the 2008/2009 financial crisis. Repo rates have since stabilized because of actions by the Fed and the belief that the event was caused by a one-off liquidity imbalance, triggered by the settlement of newly issued Treasury securities coupled with corporate funding needs for quarterly tax payments.
While these exogenous events could have easily prompted a sharp decline in risk asset prices, equities closed out the week with modest losses. For the week, the S&P 500 Index, a proxy for the U.S. equity market, fell -0.49%. International markets, both developed (MSCI EAFE Index) and developing (MSCI Emerging Markets Index) fared slightly better and finished the week virtually flat.
The Fed Does Not Offer Any Surprises
At last Wednesday’s FOMC meeting, the Fed announced a 25 basis point (0.25%) cut in the federal funds target range to 1.75% – 2.00%. The Fed’s current assessment and outlook of the U.S. economy remains favorable and projects that the U.S. economy will grow at 2.2% in 2019, slightly higher relative to Fed growth expectations at the prior meeting. The primary concern mentioned by Fed Chairmen, Jay Powell, is weak global economic growth as well as trade policy uncertainty and the potential impact to the U.S. economy.
We expected a 25 basis point cut at this meeting and continue to believe another 25 basis point cut is in the cards before year-end. Justification for another rate cut is “insurance policy” related, in our view. Powell has noted in the past and at last Wednesday’s meeting that “insurance cuts” have historically been helpful in promoting economic growth. It is obvious that the Fed’s primary goal is to maintain the current expansion and limit economic disruption as much as possible. From there it really depends on economic growth overseas as well as how trade policy unfolds and the combined impact to the U.S. economy.
The news didn’t prompt any material fluctuations in equity prices or interest rates across the yield curve. The 2-year and 10-year U.S. Treasury yields did fall 11 basis points (0.11%) and 18 basis points (0.18%), respectively, for the week, but most of the move lower occurred earlier in the week following the Saudi oil field supply concerns.
Small Caps Not Gaining Ground
Small cap stocks, which are often viewed as proxy for risk taking in the equity markets, have been consolidating for the past 6 months. The Russell 2000 Index has rallied sharply since last December 2018 lows, but contrary the S&P 500 Index, has failed to break out to a new high over the past 12 months. This marks the third longest stretch since the beginning of the current economic expansion that small caps have failed to register a new high.
Russell 2000 Index: Indexed to 100
(10 Years Ending 9/20/2019)
Source: FactSet, Inc.
Our Take on Last Week’s Macro Developments and Views Going Forward
There was a lot to digest this past week in addition to the normal bout of economic reports. In short, we obtained no new information that resulted in a material shift in our outlook. The concerns that drove volatility back in August 2019 (i.e. United States/China trade escalation and rapidly falling interest rates) appear to have stabilized, a least for the moment. The lynchpin for this expansion has arguably been the resilience of the U.S. consumer, which is showing no visible signs of weakening.
We do have some concerns regarding the price action of small cap stocks. That said, we think it’s quite possible that this segment of the market begins to gain ground as long as trade-related tensions don’t escalate further and there are no material shifts in the outlook for corporate profits.