October was a strong month for global markets. Domestically US stocks rose a little over 2%, while internationally it was a bit better for US investors as local markets rose and the US dollar weakened. Investment grade bonds were generally profitable, but not as strong as equities. The market for riskier high yield issuers remained relatively healthy and liquid.
At the end of October, the US Federal Reserve cut its overnight rate by 0.25% for the third consecutive time. This easing cycle has seen the Fed take the target rate from a high of 2.50% to 1.75%. During the process, the yield curve has steepened. One can read the steepening as the market no longer pricing in a Fed induced recession. The Fed has indicated it will take a meaningful change in the outlook for further cuts to be warranted. We view that as them telling the market that they are pausing for now. It is worth noting that there are significant differences of opinion within the Fed on where they go from here and presumably what is deemed “meaningful”. Presently, the market seems to be pricing one more cut in early 2020. We think we will probably need to see some market turmoil to get it.
Perhaps more significant than the rate cuts, were the Fed’s steps to ease strains in the short-term funding markets by buying treasuries, about $60 billion per month. Put another way, the Fed is again expanding its balance sheet. The Fed claims this is not another round of quantitative easing (QE). We think QE has a pejorative connotation and this may just be a re-branding. Regardless of what you call it, we would expect this to be supportive of asset prices and multiples.
Why they are doing this? During the last couple months, some hiccups in the overnight funding market have caused the New York Fed to provide liquidity and banks have been drawing on this liquidity. Liquidity injections conjure up memories and fears of another 2008 scenario, because other banks are not stepping into the market, but this time around we think it is less concerning. Given all their capital requirements, combined with the small size and episodic nature of the profit opportunity, it doesn’t make sense for the big banks to provide liquidity. This is where the NY Fed steps in. We are, however, a little surprised at how fragile the underlying plumbing of the money markets still are, but the circumstances here seem benign.
Overall, the economic and market data has been mixed. Manufacturing data has been soft, but the consumer has been strong. Inflation has been below the Fed’s target, but employment has been strong. This earnings season has seen corporate profits contract, but not as badly as forecast. Recent GDP reports indicate that the economy is still expanding but the pace is not what some would like. Perhaps they are still anchoring their expectations to an economic climate that has changed. At the end of the day, we believe that equities tend to follow earnings and cash flows over time. For now, earnings growth has slowed, but we think that may be more indicative of a reset than a recession.