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July 2019 – 3 in 3

July 2019 – 3 in 3

This month Jason Weaver discusses the Fed Policy, inflation components and asset class correlation.

Fed Policy

The Fed has been the primary driver of asset prices in 2019. The basic mandate is price stability (measured in inflation) and full employment. So, what is going on with the Fed? If you look back to July of 2018, the economy was doing very well. Inflation moved up to about 2.5-3.5% by October. The Fed was talking about raising interest rates two to three more times. Fast forward to now in July 2019, and the stock market is pricing in a 100% probability of a rate cut of 25 basis points. And a 65% probability of 50 basis points with two to three more rate cuts by the end of this year.

The Fed is trying to reflate asset prices. If you look back to the end of December 2018, the stock market fell as interest rates were moving up and they are trying to reflate stock prices. They do this by reducing interest rates.

Inflation Components

The inflation components that allow the Fed to do this have started to moderate. This is the price of goods and services. As you look at those goods and services, you want to look at the components of inflation. Food and beverage is running about 2%. Housing, which is hurting renters, is at 42% of inflation. Energy has been negative and medical is running about 2%.

We look at headline CPI and Core CPI. Headline CPI looks at everything together. Core CPI strips out energy and food, which are more volatile components of inflation.

Asset Class Correlation

We look at the main asset classes of equities, bonds, alternatives and cash/equivalents. There has been a tremendous correlation between those. If you are invested in the S&P and compare it to the S&P, the correlation is 1. The correlation between the S&P and US Aggregate Bond is negative (at -0.15). Commodities have a 0.38 correlation and cash is at 0.03.

Looking in to 2019, all of the asset classes are up. Stocks up 20%, bonds up 5.87%, commodities up 7.52% and cash is up 1.14%. By allowing the Fed to reflate asset classes, they’re hoping to get inflation back and the economy moving in the right direction.

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June 2019 – 3 in 3 Market Update