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).
Global equity markets are enjoying a swift recovery following their “distracting” adjustment last month. The S&P500 is up +5% over the first 10 trading days in June (thru 6/14), even as the trade dispute between the US and China is yet to show tangible signs of renewed repair. For the most part, improvement is being attributed to a more accommodating tone developing from Federal Reserve officials as they communicate their thoughts on the path of monetary policy and appear tipping their hat to a yield curve that is now inverted across some key maturities. The inversion in shorter-dated maturities is long thought a message that monetary policy is too tight for the economic conditions and outlook. It is in that regard that weaker economic data is now the market’s counter-intuitive friend. Just as strong economic data suggests to the Fed that tighter monetary policy is appropriate to keep the threat of inflation at bay, weaker data gives the Fed support to shift to an easier and more accommodating monetary policy even though the economic cycle is long. Bad news is good.
With just four trading days remaining for May, the “rear-view mirror-ists” will be quick to say investors should have expected the noticeable pullback coming (nevermind that the month of May was firmly positive in each of the last 5 years). The S&P500 is off -3.9% with most attributing the decline to renewed tension between the US and China over trade-related policy and the fact is that until recently, most investors anticipated a trade agreement was not just close, but a virtual certainty in early 2019. Combined with a US Fed that now seems firmly on hold from any additional interest rate hikes this year, the stock market enjoyed support. While the Fed still appears content with its patient posture (very important), a truce between the US and China on trade is no longer in clear sight. Interesting is that smaller-size companies which are often believed to be more insulated from the dynamics over global trade and should in theory experience less influence from tension are actually faring noticeable worse in this latest war of words. But more telling perhaps is that international equities and those domiciled in Asia especially are really getting crunched compared to US domiciled companies.
Following one of the best four-month stretches for equity markets in recent memory, the month of May is proving more challenging with the S&P500 experiencing its worst week of the year. Despite a better than expected quarter of economic growth during the 1Q and earnings that are not as soft as feared, optimistic sentiment of investors that propelled the markets to swift recovery is now deteriorating due to escalating tension between the US and China in its ongoing trade negotiation. The US view is that China backed away/recanted from prior commitments and broke the deal. As a result, the S&P500 suffered a setback of -2.1% last week even despite a late-day rise on Friday (perhaps a show of optimism that drama between the US/China might progress over the weekend). That trade-related uncertainty and market pressure looks set to continue into a new week on headlines that discussions over the weekend made little progress and actually seem to be moving further apart. Abroad, international equities and emerging markets in particular are being punished more acutely as evidenced by the MSCI EM index forfeiting -4.5% last week.
It should be news to no one at this point that 2019 is off to a fantastic start – at least for investors who continued to “stand in the pocket” despite getting repeatedly knocked down during 4Q’18. As many market participants believed at the time, the reaction by the financial markets to perceived slowing of economic growth that was anticipated (and is playing out) during the 1Q was overdone. But in fairness to investors, perceived Government missteps (or perhaps more fairly described as inflexibility) both on monetary policy evolution (Fed tightening) and Trade (US-China) made it hard to maintain confidence in officials being able to do the right thing for the US economy in the face of persistent international economic weakness and uncertainty. Since that time, sentiment on both items has turned more favorable, leading to a swift recovery for domestic equities. Investors also find themselves questioning whether they have been too pessimistic over international economic and financial market prospects. Significant economic, regulatory, and political uncertainties hampered international investing success for much of this 10-year cycle, but lesser acknowledged is how much has been done to improve monetary policy transmission in support of the banking system and economic growth. This sets international markets for potential out-performance especially when considering valuations overseas are more attractive than domestic on a number of measures and the currencies are cheap relative to USD.
The 1st Quarter concluded with each month firmly in positive territory and a cumulative advance for the S&P500 of +13.6% – a sharp reversal from the experience suffered closing out 2018. Interesting fact: since 1950 there are only 19 examples of the S&P500 starting a year with positive performance in January, February, and March and returns over the following 9 months historically came in above average (though mid-year corrections were just as likely). The early year improvement has been most attributed to a decidedly more deal-seeking tone on the issue of US-China trade and a US Federal Reserve that now appears firmly on break from any additional interest rate hikes or incrementally tighter monetary policies. While those developments are welcomed, the forward-looking message to be gleaned is far less clear. In recent weeks for instance, smaller-size companies along with transportation and industrial sectors have been laggards. Too, it is widely expected that the US economy has entered a decidedly more sluggish period of economic growth and safe-haven bond yields have drifted lower; a condition usually accompanied by a risk-off mood and caution.
It was just the 2nd down-week of the year, but below the surface many individual names have been consolidating since mid-February. The S&P500 gave back -2.1%, but the more cyclical and strongest YTD performing areas are pulling back more sharply with transportation stocks down -3.3% and small-caps off -4.3% (Russell 2000). This weakness should embolden the somewhat consensus call that that the rally since the Christmas eve low was too strong for such a short-period of time and without any retesting.
Major US indexes added to already impressive gains last week with the Dow, S&P500 and Nasdaq each adding between +2.4% – 3.0%. Just eight trading weeks into the new year, the Dow and S&P500 are up roughly +11% from where they entered; and higher-beta corners of the market (such as small-caps and cyclical transportation stocks) are enjoying even stronger recoveries in the neighborhood of +15%. The numbers are even more impressive if one begins their count from the Christmas Eve low. Interestingly, as equities have improved back to, and even through, the most obvious levels of technical resistance the pace does not seem to be slowing despite what remains a quite lengthy list of items that need to “go right” for the US economy to manage a soft economic landing.
After an impressive 4-week rally, US equities appear to be butting up against arguably their first formal area of technical resistance being near the 200-day moving average. The broad-based strength that began the day after Christmas is in recent days turning decidedly more sideways; for the week ending January 25 the Dow managed to finish slightly higher and extend its weekly winning streak to 5, but the S&P500 (considered to be broader and more representative of the overall market) slipped slightly.
US equities capped a 4th consecutive week of gains, bringing US equities back roughly +13% thru this past Friday from its Christmas-eve lows. As one might anticipate, the markets are also off to an extraordinarily strong New Year start with the S&P500 up +6.6%; encouraging, more economically sensitive areas of the market like small-size companies are faring even stronger over that period with gains of roughly +10% (Russell 2000). Most of that strength is being attributed to a more collaborative narrative surrounding trade negotiations between the US and China, as well as a more data-dependent and cautious Federal Reserve as it relates to normalization of monetary policy. The only missing element of full improvement from a domestic policy perspective at this point is that the US government remains partially shut down and there is little sign of either side appearing willing or desirous of reaching compromise. In any event, the stock market’s strong rebound serves valid reminder of how quick and suddenly direction can reverse course in financial markets, even as worries are not fully resolved.