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Before & After

Episode 1: The Fed rate announcement and Apple earnings report

Episode 1 - Part 1

Apple Earnings & the Fed

Published on: October 29th, 2019 • Duration: 8 minutes

In this inaugural episode, we look at the Fed rate announcement and the Apple earnings report.

  • [00:00:04] As investors, we all know that we can make big profits or losses around major economic or corporate data releases. In this show, we're going to discuss which of those could move markets in a meaningful way and then address how to play them. The show is going to be in two parts. We have the before part, which is going to look at what's coming up, expectations going into that event and the different ways which results can move asset prices. And then we've got the after portion where we look back at what actually happened, how it affected prices, and then learn from that price action for future trading. You see what we're going for here? Great. This week, you might think we're going to focus on Apple's earnings results coming out. Not this week. We think there's something much more important than that to focus on. This week could see an event that could dictate asset performance for the rest of the year. On Wednesday, the FOMC, that's the Federal Open Market Committee, also known as the Fed, will make their decision on interest rates. Why is this so seismic? It's because the Fed has effectively been propping up the world economy for the last decade and keeping interest and therefore borrowing rates low. How do we get to this? No surprise it all started in 2008. Not many of us are going to forget the economy in 2008, which was having a massive heart attack. So the Fed had to do something drastic to assure basic things like banks had enough cash to cover deposits. Their solution was to set interest rates at zero to try and support the economy. But that wasn't enough. When the crisis started spiraling out of control, they entered the bond market as a buyer and for some time they were the only buyer. It's this process that's called quantitative easing, but luckily it worked. It helped stop the carnage of what was a real financial panic by showing investors that the government would always do something to save bank deposits. Over the course of the next nine years. The Fed kept printing cheap money. In fact, its balance sheet reached 4.5 trillion U.S. dollars. By doing this Central banks distorted the natural order of markets, and the world has become dependent upon a constant flow of cheap money. And it meant that the US economy picked up. So after a while, the Fed tried to get things back to normal by raising interest rates and unwinding the now inflated balance sheet. This is called quantitative tightening. It was going well until the equities market skidded in the fourth quarter of 2018. It spooked the Fed, who then decided to put the brakes on quantitative tightening and interest rate hikes. So where are we now and why is Wednesday's announcement so important? Well, Jerome Powell, who is at the helm of the US Fed, is tasked with the unenviable burden of balancing a US economy that's sending mixed signals. We have the weakest ISM manufacturing data in over 10 years, but we have an employment picture that remains firm and a US consumer that's unfazed. And that's not all. He's under political pressure from President Trump to cut rates as the US is heading into an election year. What could they announce and how could it impact the market for investors? Well, firstly, we could see no change to rates. Secondly, a 25 basis point cut. Thirdly, a 50 basis point cut. The market recently placed a 90 per cent probability that the Fed will cut the benchmark interest rate by one quarter of a percentage point. At this October meeting, the Fed has never failed to deliver when market expectations have been that high. So what happens if they deliver on the quarter point cut? Given that the market is 90 percent sure that there's quarter point cut is going to happen, it's fair to assume that it's already priced into people's expectations. Of course, it also means that were it not to happen, the reaction would be sizable. The expected 25 basis point cut means the dollar should return towards the middle of its range. Bonds should edge lower and yields edge higher. Equities, well, they're going to struggle to push on because they're already near their all time highs. But and it's an important but, The market may be more confident than the Fed, and the Fed itself hasn't been as predictable as it has been in the past. At the start of the year, the Fed was making decisions that were unanimous, but by the September meeting, the committee was split seven to three. So what would happen if the Fed failed to deliver on the quarter point rate cut that everyone expects and instead made no cut at all? Now, that would be interesting. Number one equities will sell off hard and fast. And the biggest down day of 2019, which was down 3 percent,  well, that could be eclipsed. Number two, treasuries. They'll also sell off. And remember, the US 10 year yield is within striking distance of that crucial 2 percent level. And thirdly, the dollar would probably explode to the upside, causing huge pain in emerging markets and all the commodities such as oil and copper. They'll dislike a strong U.S. currency. And then there's another twist in the tale. What if they shock the market and not only held interest rates at the same level for now, but indicate that they're actually planning to move them up in the future? Stocks would plummet and yields because there would be a fear of global economic slowdown. Luckily, this is very, very unlikely. All right. What if they went the other way and they cut by half a percentage point instead of the quarter that everyone else is expecting? Well, this really would be a shock. In fact, the market has given it a zero probability. What else should we be looking for? The Fed will also release an accompanying statement which economists will pore over for signs of life. The Fed may use this to signal that the cut they've made is the last one for a while. It'll probably be described as the completion of the mid cycle adjustment and it could be the pin that pops the equity balloon. No more cuts to come for a while is negative for equities, especially with expectations where they are. Alternatively, if the Fed sees no inflation and healthy asset prices rather than bubbles, then the equity party carries on. And talking of parties, if the Fed sees global manufacturing weakness  taking a sharp drop lower and suggests they're ready to cut interest rates a lot more in the future than the equity fears that will rage on because equities love cheap money more than they love growth. OK. A lot of scenarios here. So what's the bottom line? Right now, equity markets worldwide are a bit stretched to the upside. The risk is that people are so expectant of a quarter percentage rate cut that if it happens, there'll be an anticlimax. And stocks will drop off their highs. Having said that, remember, the Fed will always have your back. We can't forget about Apple entirely. And the reason we must focus on Apple is that large tech is having some big moves. Just last week, another tech juggernaut, Amazon, reported slightly worse results. And the stock got taken to the cleaners, down 9 percent in the aftermarket. And then it opened up another 6 percent down the next day. Why does this matter for Apple? Well, it shows that stocks, especially tech stocks, are priced to absolute perfection. Any hiccup at all could lead to some short term profit taking. So what should we be looking for? The key metric we need to focus on is iPhone shipments. The number the street wants to see is forty two point three million. A miss on shipments and the stock could pull back to the twenty three point six Fibonacci retracement level at two hundred twenty six dollars and 90 cents a share. And that wouldn't be unreasonable in short term profit taking roughly a 7 percent sell off. Well, that's kind of like Amazon. Remember, the FOMC is earlier that day and so it will be Jerome Powell and his pals in the Fed that are going to dictate the market. I'm Jamie Macdonald. Thanks for watching. Before and after. And I'll see you again on Friday. 

Episode 1 - Part 2

The Fed’s Bet and a Brexit Update

Published on: November 1st, 2019 • Duration: 7 minutes

We look back at the Fed’s decision to cut rates, analyze the current state of the UK and Brexit, and break down the massive importance of unemployment data to the Fed’s impending meeting in December.

  • [00:00:04] We all know that we can make big profits or losses around major economic and corporate data releases. We're going to look at which ones could move the markets in a meaningful way. Even the staunchest of bears cannot look you in the eye and tell you the job market in the US sucks. It could very well be that the job market is the main reason we avoid recession altogether. You see, after a series of very poor manufacturing data, including the Institute to Supply Managers assessments of the economy, the ISM that was in contraction territory, the last payroll released in September provided some welcome respite for the market with an in-line figure and a robust revision to previous months. Equities rallied back towards the highs because the data was sufficiently strong to dispel fears of a recession, but not strong enough to derail the expectations of another rate cut by the US Central Bank. Jerome Powell also identified the robust job market in the US as a reason to pause rate cuts here. At 1.75 Fed funds level. That is why all eyes will be on non-farm payrolls today. Yeah, it's a lagging indicator, but revisions to the last released numbers have been upwards. Job number is one of the last bastions of strength in a broader U.S. economic picture that is showing some signs of cracks in its foundation. One could argue that a softer payrolls number would be bullish because it would pave the way for another rate cut in December. However, last month the equity market began its next leg up on the back of an in-line number. Just days after that tepid ISM report that had created a bit of a panic, what markets really want is enough signs of economic strength to avoid recession, but also enough uncertainty to keep the Federal Reserve dovish. The Goldilocks economy of middling growth. What's the current forecast? Well, the bar is pretty low. The Reuters poll forecasts for the change in non-farm payrolls is a gain of 89000. To put that in perspective, there's only been a handful of lower readings in the last five years. During this time, the average reading was 201,000. The market wants the Fed to see an economy that seems sort of weak but not falling off a cliff. So therefore, a super weak payroll number. That's a number that falls short of 89000 forecast and with downward revisions to prior number. Well, that could see equity markets take a tumble. The next rate setting meeting is not until December the 11th, and that's a long time to wait. You see, it's important to remember that with the markets and the economy, it's all about momentum, a very strong number like 200000 or more, well that would indicate that the economy is still motoring along nicely. It may take a December rate cut completely off the table, but it will help offset some of the economic concerns we've seen recently. People will be watching as the IRS and manufacturing data is released later today. Play this number straightforward. A release that's higher than 89000, anywhere up to 150000; That validates the Goldilocks scenario and it will be met with a risk on appetite. Anything between 50 and 89000. And we should see profit taking in equities, which are at their all time highs. A strong bet in treasuries rates lower. And that would keep the Fed in the game for a December rate cut. Below 50000 is a particularly negative number and that would put the Fed in a bind.  Over 200000, people are going to be looking around and saying, where's the slowdown? Finally, keep one eye on average hourly earnings and hours worked. If the jobs added is strong, but the hours worked and the earnings per hour fall, well, that might indicate that the robots are taking all the good jobs and that workers have been relegated to the menial tasks. The old adage that one economy sneezes and another catches a cold certainly rings true, especially when we're talking about Europe and the US. So it's really important to keep an eye on what's going on globally and not just focusing on the US. The UK continues its saga to leave the EU writing a seemingly unpredictable chapter each week. Well, that next chapter is now an election on December the 12th. But what effect is all this uncertainty having on the UK economy? Clearly, it's not great. But exactly how bad and what does it mean? We'll see. In the UK election campaigns, the big upcoming data point is the UK Construction PMI, the UK Construction Purchasing Managers Index. It measures the performance of the construction industry, which is clearly a good indicator of economic activity, and it's something that's been sliding all year and bouncing around recessionary territory for the last few months. This is a big deal because remember, the UK is about to undergo a lengthy process of renegotiating its trade deals with Europe and the rest of the world. So it needs to have a strong economic foundation to negotiate from to get these good terms. These are unnerving times for a typically reliable economy. If this is a weak figure, well this is going to give the Conservatives and Boris Johnson the ammo he needs to do two things. One, he could tell the country what he's been saying all along, that a fast and efficient exit is the way to go, as all these delays are impacting the economy. Secondly, he could present a sizable fiscal spending package to get the economy back on track. The key here is that the weaker the data, the more emboldened the conservatives are to announce big spending packages, something they are not historically known for. The clue, after all, is in the name of the party. And while Labor will shout that the situation is the fault of the conservatives, it will go back and forth. If it's clear that all the parties are going to throw bucket loads of cash at the electorate, well then we should be pricing for a pickup in longer term UK inflation. That might finally start to close the gap between the UK and the US 10 year bond yields. This reflective chart shows where they diverged in 2016 after the Brexit vote. After having danced to the same tune for the previous 15 years, so the Fed delivered a 25 basis point cut. This, as we said, was 90 percent likely. So no shock at the headline level. There was clearly enough evidence for them to cut this time. However, in the statement, the Fed removed the words ready to act and instead they will continue to assess financial conditions, hinting that they may pause rate cuts unless anything major happens. This means rate cut expectations in December have decreased, and it's why equities have done well. But again, like we said before, equities are going to struggle to go much higher because they're already so stretched and it would have to take something pretty sizable to take them to the next leg up. What's the conclusion? The market likes what the Fed is doing, which is to remain on the sidelines for now. Given the data they are seeing and send a message to the world that they see no reason to have a rate cut because basically the economy's doing fine. Sure, there are global slowdown pressures and trade concerns, but that's what the cut was about. For now, monetary policy as they see it, is well-placed and that's good enough for stocks. What could displace that? Well, for sure, the trade truce falling apart would send equities lower and it might make them rethink the strategy. But really, as Jerome Powell said himself, is going to be the jobs data that influences them the most. We will see if that's true on December the 11th at the next FOMC meeting. I'm Jamie Macdonald, and we'll see you on the next episode of Before and After.

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