The S&P 500, tracked by the C Fund, continued a choppy sideways pattern last week near the psychologically important 3,000 mark.
The week began with sell-offs, but ended with two days of rallying on optimism for a partial trade deal as Chinese officials met with President Trump and his team of advisors. The market remains below its July 2019 all-time highs, but is within striking distance of them.
The result of this meeting was a de-escalation in tariffs and rhetoric, along with a potential addition of agricultural purchases from China, but still a significant amount of uncertainty regarding fundamental pieces of a grand trade deal, such as intellectual property rights and other structural issues.
Apple in particular hit new all-time highs last week on positive trade news, and regained its top slot along with Microsoft as the most valuable company in the United States and the biggest weighting in the C Fund.
Apple was previously the most valuable company in the United States, but its stock fell by approximately 35% over the past year, and it has just now recovered to new highs. China is one of Apple’s largest markets, and trade war escalation can hurt their sales there in various ways from citizen boycotts to government blockage.
Microsoft, meanwhile, is less dependent on China, and until Apple’s recent comeback, Microsoft had overtaken it as the most valuable company by a wide margin. Now they are tied again as two companies each worth $1.07 trillion.
Although the ongoing trade war hogs the financial headlines and can create big daily swings in equity performance, I view the upcoming third quarter earnings season as likely being more important for durable market direction. Throughout the rest of October, we have most of the companies in the C Fund reporting earnings, and their results may provide a lot of tangible data on the direction of the economy. I remain cautious here, and believe that diversification is very useful in this type of market environment.
The Federal Reserve Resumes Balance Sheet Expansion
The Federal Reserve announced that they will begin buying U.S. treasuries at an initial rate of $60 billion per month until at least the second quarter of 2020, to increase the size of their balance sheet and provide liquidity into the banking system. Just a few months ago, the Federal Reserve was performing quantitative tightening (reducing the size of the balance sheet), so this is a major shift in U.S. monetary policy.
A few weeks ago, I wrote about the sudden spike in overnight lending rates that required the Federal Reserve to step in and inject cash liquidity on a daily basis:
There was considerable confusion in the financial media about why this was occurring, with narratives ranging from a banking crisis similar to 2008, to just a short-term financial plumbing issue. In that article, I showed that the primary reason had to do with foreign sources no longer buying U.S. treasuries over the past five years, which forced domestic balance sheets to absorb a large amount of the treasuries. Combined with larger than normal federal deficits, this eventually proved too much federal debt for domestic balance sheets to hold, and liquidity dried up, and I wrote that unless foreign buyers step in again, the Fed would likely need to expand its balance sheet.
This past week, the Fed announced that they will do exactly that.
Historically, this type of balance sheet expansion is a variable that can weaken the dollar compared to other currencies, which may boost the performance of the I Fund, and especially emerging markets which unfortunately are not yet included within the I Fund.
However, there are several variables that affect exchange rates, so nothing is for certain. I’ll be monitoring the direction of the dollar to see if a clear trend is forming or not, due to how important it is for I Fund returns.
For now, the noteworthy news is that the dollar broke below its 50-day moving average on Friday for the first time in three months. It remains historically strong against other currencies but its recent upward trend has been broken on the news of the Fed expanding its balance sheet.