Too much credit for the stock market ascent has been assigned to the Powell Put, the assumption that Federal Reserve Chairman Powell will stay accommodative until the economy accelerates and stocks reach new highs. A Put option is a hedge against downside risk, a protection vehicle that increases in value as prices decline. We agree with the premise of the Powell Put, but not the emphasis accorded by market pundits. It was always a given that the Fed would quickly shift to a dovish posture on interest rates once stocks capitulated more than 15% and economic signs of deceleration were obvious. The far more fateful factor is the outcome of a China Trade Deal. The China Call is a bet of a successful trade deal. A call option appreciates with the price of the underlying asset and much of the January surge in stocks can be attributed to the growing confidence in a successful trade Deal between Trump and President Xi of China. The China Call is in place and should it be removed by the trade deadline of March 1st with new tariff battles, then you can bet that the Powell Put will be helpless to stop the markets descent to new lows. Like the positive investor consensus, we also assume there will be a framework of a trade deal that prevents a renewed tariff war escalation phase, such as the one that greatly acerbated the 20% equity market correction in major indices in the 4th quarter of 2018. Between the the Powell Put and the China Call option, any February correction could be as mild as 3% or as much as 8% if there are signs of rising tension between the US and China negotiators. An eventual trade agreement should boost equities above their November highs.
The stock market correction in late 2018 over fears of decelerating economic growth and weaker corporate earnings in 2019 may have been a blessing in disguise for the stock market and our economy. With extreme tightness in the employable labor supply and an unsustainable 3%+ GDP expansion rate, our country desperately needed a Goldilocks slowdown. A couple quarters of GDP growth in the 1.5 to 2.5% range to ease the 2018 supply chain overload and capacity constraints will allow increased operating efficiencies, inventory balancing and geographic shifting of resources. The baby boom and new cultural female workforce explosion in the 1970’s – 1990’s allowed potential GDP growth of 3 to 5%, but demographic capacity constraints here and among all 1st world countries limits healthy growth rates in major democracies to the 1 to 3% range. Falling back into this growth range before reaching an inverted yield curve or elevated credit risk of past economic cycle peaks will allow the current expansion to extend its endurance record. With the entire world minus the US slowing sharply in 2018 and all countries sluggish in early 2019 we are setting up for new monetary and fiscal stimulus efforts from all nations. New trade deals would maximize these efforts along with an important rebound in consumer and business sentiment delaying recession risk that consensus is targeting in 2020.