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The Market Sum | Insight after the bell

By Caleb Silver, Editor in Chief

Thursday, August 27, 2020 Headlines

1. US markets rally on Fed's surprise new inflation policy

2. The DJIA crosses into positive territory for 2020

3. Hurricane Laura downgraded as it makes landfall

4. Decoding the Fed's inflation policy changes

5. Stock investors have had a historic 20 year run

Markets Closed

Dow
28,492.27
+160.35 (+0.57%)

S&P
3,484.55
+5.82 (+0.17%)

Nasdaq
11,625.34
−39.72 (-0.34%)

VIX
24.51
+1.24 (+5.33%)

Bitcoin
11,286.06
−195.74 (-1.70%)

US 10-Yr Yield
0.746
+0.059 (+8.59%)

Image courtesy GettyImages/Salvatore Massara/EyeEm

Markets Today

U.S. markets ripped to new highs today following the Federal Reserve's surprise change to its long-held stance on inflation targets, effectively guaranteeing ultra-low interest rates for years to come (more below). The DJIA climbed nearly 160 points, or 0.57%, and it briefly went positive for 2020. It is having its best August since 1984. The S&P 500 closed slightly higher, topping new records again. The Nasdaq gave up early gains to close in the red, but it is having its best August since 2000.

Hurricane Laura made landfall in Louisiana early this morning, knocking out power for at least 500,000 people. It eased into a tropical storm as it came ashore, and it may spare the region the worst of its wrath. Oil prices ticked down 1%, as the damage seems limited.

Gold prices fell as stocks roared higher, a continuing trend that has been playing out for several weeks after the precious metal hit record highs in July. Volatility, which had been on a summer vacation, streaked back into the stock market today for the first time in weeks. A rush into equities will do that, but let's see if it sticks around.

Chart courtesy YCharts

[NEW READER SURVEY: We are running another two-week survey of our U.S.-based readers to gauge your sentiment and see what moves, if any, you have been making with your money given the market recovery and current economic conditions. We'll share the results, as always, and we thank you for your time and participation.]

Headlines:

The FDA has issued emergency use authorization for Abbott Laboratories' (ABT) fast and affordable COVID-19 test. The credit card-sized BinaxNOW device delivers results in 15 minutes, requires no extra lab equipment, and costs $5 each. The company will ship "tens of millions" of tests in September, ramping to 50 million tests a month at the beginning of October. President Trump plans to announce Thursday the purchase of 150 million of the tests as part of a $750 million agreement with Abbott Laboratories, as part of his speech at the Republican National Convention tonight. Shares of Abbott Labs rose 8% today, hitting a 52-week high.
Walmart said it is joining Microsoft's pursuit of TikTok's U.S. operations, adding another wrinkle into the pursuit of the popular short video-sharing app. The Trump administration has pushed TikTok's owner, Chinese technology giant ByteDance Ltd., to sell its American operations after targeting the app over national-security concerns. Oracle and Alphabet are also reportedly bidding for the app.
The worldwide smartphone market is forecast to decline 9.5% year-over-year in 2020, with shipments totaling 1.2 billion units, according to the International Data Corporation (IDC) Worldwide Quarterly Mobile Phone Tracker. While the second quarter of 2020 (2Q20) resulted in slightly better-than-expected numbers, the market was still down 17% year-over-year with visible signs of economic concerns. On a positive note, IDC expects the smartphone market will return to a full recovery by 2022 and will achieve a compound annual growth rate (CAGR) of 1.7% over the next five years.
TikTok CEO Kevin Mayer has resigned amid the app's struggles with the Trump admin. Mayer left his role as Disney's streaming chief to take the reins at the social media company in May. "As the political environment has sharply changed, I have done significant reflection on what the corporate structural changes will require, and what it means for the global role I signed up for," he said.
Bed Bath & Beyond is laying off 2,800 employees from across its corporate headquarters and retail banner stores. This is expected to generate annual pre-tax cost savings of $150 million and is part of a larger restructuring plan expected to deliver $250 million to $350 million in annualized EBITDA improvement.
Fidelity is launching its first fund dedicated to Bitcoin, its latest foray into cryptocurrency. The money manager will begin to offer the Wise Origin Bitcoin Index Fund I through Fidelity Digital Funds. The fund will be made available through family offices and investment advisers with a minimum investment of $100,000, according to Bloomberg.
Trading was halted on New Zealand's stock exchange on Thursday for a third day in a row following a cyber attack earlier in the week. New Zealand's Exchange said trading in its cash markets stopped at around 11:10 a.m. local time due to network connectivity issues relating to this week's cyber attacks.
Amazon rolled out Amazon Halo, a health and wellness tracker that the company said also tracks its users' emotions, in its latest foray into wearable products. The wristband and app track body-fat percentage, heart rate, and its users' activity and sleep, among other features, Amazon said Thursday. The product, Amazon's first entry into the health and wellness space, is available for early order in the U.S. starting Thursday.

Amazon Halo courtesy Amazon.com

The Federal Reserve's Big Inflation Shift

The U.S. Federal Reserve has been full of surprises in 2020, enacting monetary policy measures many had never imagined. It is buying corporate bonds, bond ETFs, and implementing a host of other measures that have arguably rescued the capital markets from the grips of a severe bear market. However, that's not its job.

The Fed's job is to set monetary policy to maximize employment and keep inflation at or near its stated 2% target … at least that's what used to be its job until this morning.

Fed Chair Jerome Powell announced this morning that the Fed will no longer be beholden to its 2% inflation target over time, but it will seek to keep inflation averaging around 2% over time. In doing so, the Fed is effectively abandoning a strategy put in place in the 1970s to counter rampant inflation. It's been operating under the theory that a strong labor market would lead to price inflation in what is known as the Phillips Curve.

Unemployment, before the pandemic, was running at historical lows and had been since the end of the financial crisis. Inflation has also been stubbornly low, which hurts producers' pricing power and harms growth. Not only has inflation been low, expectations for future inflation also remain low, as you can see in the 5-Year Forward Inflation Expectation Rate:

Chart courtesy FRED/FederalReserve

Here's how the Fed put it in its statement:

On price stability, the FOMC adjusted its strategy for achieving its longer-run inflation goal of 2% by noting that it "seeks to achieve inflation that averages 2 percent over time." To this end, the revised statement states that, "following periods when inflation has been running persistently below 2 percent, appropriate monetary policy will likely aim to achieve inflation moderately above 2 percent for some time."
The updates to the strategy statement explicitly acknowledge the challenges for monetary policy posed by a persistently low interest rate environment. Here in the United States and around the world, monetary policy interest rates are more likely to be constrained by their effective lower-bound than in the past.

Translation, Please?

Inflation has remained stubbornly low for over a decade, even when job growth was strong. Keeping interest rates low, which can causes a rise in inflation, does not seem to have had that effect. Low interest rates do ultimately lead to more hiring, and we need more hiring. With unemployment in the U.S. at 11.1%, where it might be for quite a while, the Fed needs the flexibility to keep rates low, so it will.

The Takeaways

The big takeaway for stock investors is that interest rates are low and will stay low for several years. That's been the fuel behind the rise in stocks going all the way back to 2009, when Ben Bernanke, the former Fed Chair, slashed interest rates in the depths of the Great Financial Crisis, and it has certainly been one of the main sources of the rally for stocks off their late March lows.

The big takeaway for fixed income investors is that yields on treasuries and other government bonds are going to stay low for quite awhile. Prices have been rising, so if you are a long-term holder, you've done well.

The big takeaway for borrowers is that interest rates are going to remain low, which is good news for home buyers, refinancers, and consumers considering big purchases like cars or second homes.

Stocks Love Low Interest Rates and Low Inflation

We've been in this period of low interest rates for the better part of the last two decades since Fed Chair Alan Greenspan slashed rates after the Internet bubble burst in 1999. Inflation has been trending lower since about then as well.

It turns out that that recipe has been great for U.S. equity investors. To cherry-pick a few stats, including 2020, the S&P 500 is now up 16 of the last 18 years (I know the year isn't over yet). It was up 17 out of 18 years from 1982–1999 after the ultra-high interest rates put in place by former Fed Chair Paul Volcker to combat stagflation were slashed in the 1980s.

More News:

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Key Gauge Flashing Red Amid Investors' 'Incredible Appetite for Risk'

The 5 Biggest Chinese Software Companies (CHL, TCEHY)

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(chart courtesy YCHARTS)

Shares of Ulta Beauty are up by over 18% following the beauty store chain reporting better-than-expected Q2 EPS results. Abbott Laboratories' stock price rose by 8% after President Trump announced a $750 million deal to purchase 150 million rapid COVID-19 tests from the medical devices and healthcare company.

Shares of Coty are down by 8% after the beauty company reported a Q4 drop in sales by 56% year-over-year. Dollar Tree's stock price fell by over 7% amid investor concerns regarding the sustainability of the discount variety store chain's recent success.

Word of the Day

Phillips Curve

The Phillips curve is an economic concept developed by A. W. Phillips stating that inflation and unemployment have a stable and inverse relationship. The theory claims that with economic growth comes inflation, which in turn should lead to more jobs and less unemployment. However, the original concept has been somewhat disproven empirically due to the occurrence of stagflation in the 1970s, when there were high levels of both inflation and unemployment.