The One Thing That Pro-Rate Cut Investors Should Watch in July

It's about to be an interesting month in the stock market. The job market, the growth of which is part of how analysts determine how fast an economy is expanding, had a strong month in June, adding 224,000 jobs, very well above economists' prediction of 165,000 new jobs. Also, that's an improvement on the 75,000 new jobs that the U.S. labor market posted in May, which was the weakest monthly job increase since the financial crisis ended in mid-2009.

Continued Economic Growth

The U.S. economy is currently witnessing its longest expansion in history and while that is a positive thing, the situation is brewing uncertainties. There're growing worries on if the current rate of expansion is sustainable. Fund managers, in every part of the industry, are at their most pessimistic level since the 2008 financial crisis, according to a recent Bank of America’s fund manager survey. The sluggish growth in May strengthens the concerns that economic growth might have peaked, especially amidst the ongoing trade war.

Investors Want Rate Cut

In hopes of further prolonging the economic expansion (that is, making sure it doesn't reach its peak just yet), investors have been hoping that the U.S. Federal Reserve would cut interest rates as soon as July. The action would lower the cost of borrowing for both consumers and businesses, which should, in turn, stimulate spending. Sustained spending typically helps sustain economic growth. However, the strong growth in the job market has dampened that hope, as it indicates that economic expansion isn't slowing down just yet.

How Earnings Could Impact Interest Rate Decision

So here, we have a sentiment-indicator disagreement. Investors, especially fund managers, think we're in a period of slow growth, consequently favoring a rate cut. Indicators, such as the job market growth and trade disputes, say the economy is still growing respectably. In response, fund managers are moving to assets such as bonds, cash, REITs and utilities, that tend to outperform in low growth and low-interest rates cycles.

With the earnings season now upon us, the focus is now on the stock market. Wealth manager Michael K. Farr wrote the following in CNBC:

"The problem is that artificially pumping up the stock market to these lofty heights [facilitated by interest rates cut] without a corresponding increase in earnings would pose a significant risk to the economy."

The logic is that for a rate cut to make sense for the stock market, earnings have to grow. Therefore, a strong earnings season, which could make stocks more valuable, may strengthen the stock market core enough to handle the new bids that a rate cut might bring.

In summary, with sentiments largely in favor of a rate cut as early as July or September, investors should keep an eye out for earnings. It could be crucial in the decision to cut or not to cut rates. The Federal Reserve would be cautious a rate cut that could artificially pump the stock market.

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Disclaimer: The writer is an experienced financial consultant who writes for Finscreener.org. The observations he makes are his own and are not intended as investment or trading advice.