Posted | by David Moenning |

Don't look now fans, but there might be some hope creeping into the stock market. With just 23 trading days left in the year, there seems to be some hope that we've seen the bottom of the recent pullback.

To be sure, two consecutive green bars on the charts of the major indices does not a trend make. And with the S&P 500 a mere 1.5% off the lows of the move, the bears contend that they are by no means out of the game.

But, unless you've been sleeping in a cave, you know that there are three primary driving forces of the current market move. The first two appear to be the main factors affecting the near-term action, while the third is the longer-term issue traders are wrestling with.

  • Fear the Fed will overshoot (and drag down the economy in the process)
  • Fear the Trade War will escalate (and drag down the economy in the process)
  • Fear that both economic and earnings growth will slow more than expected

The good news, and the primary reason behind the recent green on your screens, is that there seems to be some hope developing on the first two points.

How Far From Neutral?

On the Federal Reserve front, the question of the day is how far away the Fed is from the so-called "neutral" zone for Fed Funds rates. Referred to as "r*" by U.S. central bankers, the general thinking is that Fed Funds will need to reach the 3% range in order to be considered neither restrictive nor stimulative.

At issue is the FOMC's "view" on how much more rates need to rise. Recall that Fed Chair Jerome Powell sent the markets into a tizzy in October when he said that the current target range of 2% to 2.25% is a "long way" from neutral and that the Fed may need to go past neutral for a while.

Given that global economic data had been in decline for months and that economists were starting to see some cracks in the U.S. growth picture, this statement spurred fear that this Fed was going to be no different than its predecessors and wind up "going too far."

From a stock market perspective, this creates angst about the outlook for the economy. And since the market tends to act as a discounting mechanism for future expectations, stock prices were adjusted downward.

Currently, the Fed game is really about expectations for rate hikes in 2019. It is a foregone conclusion that Jay Powell's merry band of central bankers is going to hike rates again in December. However, the question at hand is how many more rate hikes can be expected next year?

Until recently - and before signs of economic softening began to show up regularly - the expectation in the market was for the Fed to hike rates three times in 2019, which would put the Fed Funds rate in a range of 2.75% to 3.0%. Mission accomplished, right?

However, now that the outlook for the economy isn't as rosy as it was, there appears to be a growing hope that the Fed may not blindly stick to the plan.

I've been saying for some time that the key words we need to hear from Fed officials are "data dependent." As in, the Fed will base their rate hike decisions on the data coming in as opposed to some predetermined plan. The good news is that we are starting to hear these two words with regularity.

For example, new Fed Vice Chairman Richard Clarida used the words just yesterday in a speech Tuesday. Well, to be fair, Clarida actually said the following in reference to the Fed's approach, "A monetary policy strategy must find a way to combine incoming data and a model of the economy with a healthy dose of judgment — and humility! — to formulate, and then communicate, a path for the policy rate most consistent with our policy objectives."

Close enough.

Clarida also made headlines by suggesting that monetary policy is "much closer" to the neutral zone. Markets viewed these words positively, despite the fact that the rest of the sentence went something like, "than it was when the rate-hiking began in December 2015."

For the record, this is the second time in two weeks that Clarida has talked about the Fed being close to neutral and should be data dependent going forward. And last Thursday, Atlanta Fed President Raphael Bostic said in a speech that the Fed Funds rate is "not too far" from neutral. For those keeping score at home, it would appear that the Fed may be trying to "soften" its public stance a bit.

Next up will be Jay Powell himself, who is scheduled to speak today. Here's hoping we will hear the Fed Chairman use the words "data dependent" somewhere in his speech.

Let's Make a Deal (Or Not!)

While Fed expectations are obviously important, the intraday action in the stock market suggests that it is the issue of the "trade skirmish," as Jamie Dimon termed it, between the U.S. and China that seems to move markets the most.

In keeping with the theme of this missive, there seems to be some hope building that the two sides will find a way to make a deal. This despite the fact that the country's Negotiator In Chief, Donald Trump, said early in the week that he is "highly unlikely" to accept the terms being bandied about by China.

However, markets were encouraged yesterday by comments from Trump's Chief Economic Advisor, Larry Kudlow. The former CNBC commentator said Tuesday (I'm generalizing here) that talks between China and the U.S. are ongoing at all levels and the he believed China wants to make a deal.

In response, the President declared that he is willing to follow up the 25% tariffs set to start in January with additional tariffs of between 10% and 25% on all goods imported from China. And yes, that would include the iPhone.

And so it goes. Since this President is highly unpredictable, the bottom line is we won't know there is a deal until, well, there is a deal. But for one day at least, hope seemed to be growing that a deal will be able to be reached - if not this weekend, then by the end of the year.

So, while hope may indeed be creeping in, it is important to recognize that any headline suggesting that there is no deal in sight would likely bring the bears back into the game.

Thought For The Day:

Everything that is great and inspiring is created by the individual who labors in freedom. --Albert Einstein

Wishing you green screens and all the best for a great day,

David D. Moenning
Founder, Chief Investment Officer
Heritage Capital Research

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At the time of publication, Mr. Moenning held long positions in the following securities mentioned: none - Note that positions may change at any time.

The opinions and forecasts expressed herein are those of Mr. David Moenning and may not actually come to pass. Mr. Moenning's opinions and viewpoints regarding the future of the markets should not be construed as recommendations. The analysis and information in this report is for informational purposes only. No part of the material presented in this report is intended as an investment recommendation or investment advice. Neither the information nor any opinion expressed constitutes a solicitation to purchase or sell securities or any investment program.

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