Another quiet start

US stock index futures were little changed in early trade this morning. Yesterday both the S&P 500 and the Dow Jones Industrial Average ended the session a tad lower, but within inches of their respective record highs from Tuesday.

Trump impeached

After yesterday’s close the House of Representatives, with a Democrat majority, voted to impeach President Trump. There will now be a trial in the Senate where the Republicans have a majority of 53 seats to the Democrats’ 47. As the whole process has mostly split down party lines, and as 67 senators would have to vote to convict the president, the odds strongly favour Trump remaining in office. In addition, the whole process is seen as damaging the Democrats ahead of next year’s election, increasing the likelihood that market-friendly Donald Trump will win a second term.

Bullish news

The bullish tone going into the year-end is thanks in part to Friday’s news that the US and China have reached a ‘phase one’ trade deal. In addition, last week the US Federal Reserve forecast that its key fed funds rate would remain unchanged throughout 2020. This provides some certainty for investors. But arguably the biggest boost to US equity markets comes from the Fed’s ongoing purchase of Treasury bills. This has seen the central bank’s balance sheet grow at the fastest rate since the financial crisis, although the Fed insists this is not the same as quantitative easing.

Questions about ‘phase one’

But there are some questions about both the state of the trade deal and the efficacy of the Fed’s never-ending efforts to goose asset prices. Where the trade dispute is concerned, there are differences between what the US negotiators are claiming and the view from Beijing. While the US version of ‘phase one’ puts numbers on the goods and services that China should import under the agreement, Beijing’s doesn’t. As for intellectual property, China has promised to improve its systems, but hasn’t included specifics, unlike the US team. It was a similar story where forced technology transfers and competitive currency devaluations were concerned. The only real positive is that both sides cancelled further tariffs on each other that were due to kick in over the weekend while reducing some existing ones. Overall, it looks as if there’s an awful lot of detail to fill in ahead of the signing planned for next month.

Questions about the Fed

As far as the US Federal Reserve is concerned, on Tuesday President of the Boston Fed, Eric Rosengren, warned that lower interest rates could encourage excessive risk taking and over-leveraging which would create great risks during a downturn. He confirmed that high asset prices are a direct function of the Fed’s loose monetary policy and that this leads him to have concerns about financial stability. He also said that low rates will eventually result in a financial crisis and pointed out that the last two recessions came about when asset prices “went way up and then came way down. So, if your goal is to avoid recessions, I think we need to be pretty focused on asset prices not just inflation.” He wasn’t the only member of the Federal Reserve to express concerns about an overvalued market. Dallas Fed President Robert Kaplan warned of high price/earnings ratios in the stock market, historically tight bond yield spreads and the current low capitalization rates in commercial real estate. This is despite the fact that Mr Kaplan is, with his FOMC colleagues, responsible for the Fed’s hawkish-to-dovish pivot at the beginning of this year which led to the central bank cutting rates three times and expanding the balance sheet by around $300 billion, the fastest rate of expansion since the financial crisis. All this monetary stimulus comes despite the US economy showing respectable growth, with inflation near its 2% target and unemployment at its lowest level in fifty years.

Charts

The Dow Jones Industrial Average (DJIA) continues to trade comfortably above the support line of the Andrews’ Pitchfork formed by the August, September, October pivot points. There’s been a positive slant put on US/China trade talks with widespread relief that both sides refrained from imposing fresh tariffs. Otherwise, central bank stimulus is keeping equity markets supported.

But there are question marks over how long US equities can continue to rally without a significant correction. The Commodity Channel Index (CCI), shows how quickly the DJIA has gone from oversold to overbought. At the same time, there’s still a slight negative divergence apparent, as the CCI makes a succession of lower highs as the DJIA hits fresh records with a string of higher lows. For now, there’s plenty of bullishness around. But the danger is that it could suddenly evaporate for the flimsiest of reasons.

David Morrison