The current global trade war concern first emerged 18 months ago; as recent as May it was generally believed a US/China trade deal could be negotiated. That deal on paper was reportedly 80% complete. At the same time, some trade progress occurred elsewhere (USMCA/NAFTA 2.0), but the US/China negotiations are unfinished and appear virtually collapsed. One even wonders if a US/China deal can resolve before the next US presidential election in 2020. The reality is China does not feel the same political urgency and is unlikely to back down quickly, instead they favor projecting a tough image. That means more economic pain will probably occur before meaningful talks resume. A major issue – Intellectual properties protection – is a complex subject to be resolved. In essence, it appears we are in the throes of a “New Cold War” with potential big influences on the domestic and global economic and financial outlook.
It was another roller-coaster ride of a week; one in which the most recent of market stress seemed to be attempting to mend. In fact, until Friday, the market was up a little more than 1% and the VIX, a widely watched measure of market volatility was beginning to appear calm. Investors appeared optimistic that Fed Chair Jay Powell would deliver a dovish and re-assuring tone during his speech in Jackson Hole, WY. In fact, most believe he delivered what the market was looking for: a conciliatory tone acknowledging that global economic conditions have continued to weaken since the late-July cut and monetary policy increasingly looks out of sync with the global situation specifically citing escalating trade friction.
If you watch the news today, it is almost certain you will learn the yield curve inverted (the 2yr/10yr spread) this morning for the first time since 2007. This will probably result in a challenging market experience today (and perhaps days ahead). You will also hear inversion – a condition where short term interest rates are higher than longer term rates – is significant because it sports a strong track record for correctly signaling that an economic recession develops at some point in the not distant future. With the curve flattening for the better part of 18 months, and some maturities first inverting earlier this year, we’ve discussed why we too believe the curve slope is relevant and worth monitoring. We do not dismiss the condition as insignificant; it signals that a policy mistake is being made and damage to the economy is building. It is evidence that monetary policy is too tight for the current economic situation as a whole and will become restrictive. The ongoing friction between the US and China over trade is part of that restrictive cocktail, and the Fed should not delay in responding further via additional rate cuts in the months ahead.
Almost as quick as the calendar flipped to August, the market’s backdrop and investor sentiment was altered. Just two weeks ago, the Fed made good on months of more dovish rhetoric by cutting its target for short-term interest rates by a quarter of one percent (25 bps). While some watchers were pining for a more aggressive move, the adjustment seemed all that was warranted given a stock market near all-time highs, low levels of unemployment, and trade talks between the US and China that were reportedly making progress following a late-June G20 meeting between Trump and Xi. But with a newspaper article and harsh tweet from Trump that fresh additional tariffs would be levied against China, the Fed’s easing move suddenly felt inadequate and behind the curve. Tensions between the US and China are again heightened, and some are calling the process of negotiation all but collapsed as China allowed their currency to depreciate in retaliation and appears to be slow-walking/stalling the process. They in no way seem urgent to strike a deal even as their economy is showing signs of stress as a result of tariffs. Chinese leaders instead appear of the perspective that in the “long-game”, a weakened global and US economy hurts Trump’s chance of re-election in 2020 – and their odds of a more favorable “deal” are higher when considering the stated positions of Democratic party hopefuls.
It’s pretty easy to hear the same investment theme these days “as many investors go to the same dinner”; hear the same story; and drink the same Kool-Aid. The huge world of investible assets is quickly shrunk down to just a few of the same companies owned by many. But years of tepid economic expansion and low returns cause many investors to be hesitant to broaden their holdings beyond the few stocks delivering eye-catching results. This includes index ETFs (passive strategies) that own outsize exposure to the same fast growing companies. Even today as global growth is slow there is caution to invest otherwise despite a record widening valuation gap between growth and value stocks. Additionally, money flows are more concentrated and could exasperate market volatility and drawdown for these heavily owned exposures. Did you know, the FAANG stocks provided 25% of the YTD2019 return for the S&P500? [FAANG stocks = Facebook, Apple, Amazon, Netflix and Alphabet’s Google] Together they are a large portion of the S&P500’s total market capitalization, and their growth sizzled in recent years. Yet caution is warranted as they are priced to “perfection” – requiring close awareness to their rich valuations and being widely owned.
After beginning July with a strong posture, markets seem to be pausing to catch a breath. Domestic equities slipped -1.2% during the week ending July 19, effectively halving the month-to-date performance. It is challenging to point to any single factor or headline, but perhaps most notable is the reality that corporate earnings being reported for the 2Q period are soft. When combined with the reality that the market as a whole is up handsomely YTD despite what seems to be persistent negative headlines (be it trade, geopolitical tension, yield curve inversion, etc), it’s not hard to understand why the investment community’s prevailing sentiment is that the good times will not last.
With the exception of May, 2019 is probably surprising most everyone in the investing community in quite positive fashion. Despite the realities that both economic and corporate earnings data appear to be in a trend of slowing, AND continued tariff/trade and political uncertainty both the S&P500 and Dow busted through respective round-number levels of 3,000 and 27,000 last week. So far in July, the S&P500 is up another +2.1% bringing the YTD climb to more than 20%. About 86% of the S&P500 constituents trading above their 50-day moving average. In the short-run, this probably means the market is overbought and due for a pause – that idea is also significant when one considers we are entering what is traditionally a weaker seasonal period. But more important is the message it tells about momentum present under the surface. Interestingly, all of this has happened at the same time the yield curve has remained troublingly flat (or inverted depending on the maturities inspected).
As we enter the 2nd half of 2019 it is difficult to recall a time when the market was hitting new highs but investor attitudes felt so indifferent. Rather, sentiment is guarded. This is likely due to a Federal Reserve that raised interest rates 4 times in 2018 and now appears to be “too tight” when also considering persistent uncertainty from international trade and tariff talk. Taken together, investors perceive the global economic outlook is at risk.
As this quarter’s Nvest Nsights newsletter highlights, the good news is those worries seem to be keeping the close attention of those with the power to resolve. “Can’t Live There” and “Missing – Reward” are efficient reads on the key items driving financial markets and context about the current (and now longest) economic expansion in US history. Strong starts to a year bode well for the balance, but we also submit that the path of both the market and policy (trade & monetary) adjustments may not be smooth. We also share several “Frequently Asked Questions” being received recently from clients; we hope you find those relevant and helpful.
Click Here to Download the printer-friendly PDF version of our newsletter or continue reading below.
Careful! Avoid buying life insurance as a savings strategy! Stop buying it as a tax-deferral vehicle for retirement savings!
Insurance of any kind is a risk-management tool. From our perspective, an individual should buy life insurance for one reason: because there will be a financial impact on one’s family or business if they unexpectedly die. For most individuals, that financial impact is typically highest early in life when working years ahead are many, financial assets accumulated are low, and financially dependent children and/or significant debts (such as home mortgage) exist. Over time, one’s insurance need generally declines and ultimately reduces to zero at some point prior to retirement.
With just one week remaining in the month of June, the 2Q was a decidedly bumpier and more uncertain experience than enjoyed in the first 3 months of 2019. Make no mistake however, the most recent 18 months have been anything but smooth sailing (but aside from 2017, the market rarely is) as trade disputes and the path of monetary policy are recurring sources of tremor. Still, as we look to the quarter’s final trading days this week, the S&P500 is very near to recapturing all-time highs. This follows a strong week fueled by formal communication by the Fed that its monetary policy is shifting and a cut to rates will occur when it meets in July. Also assisting the equity market is welcome news that Trump and China’s Xi will talk concerning the current trade differences at a G-20 meeting in Japan this week. The news flow is again positive from the perspective of equity markets. Yet as friendly as those developments are, this should also serve as reminder that risks remain. Research firm Strategas recently put it this way: investors and markets are presently at the whim of three people – Fed Chairman Powell (unelected), President Trump (unpredictable), and President Xi (largely unaccountable). This should caution investors from getting too complacent.