Undistracted – Market Commentary for June

If you travel through the village of Mantua in northeast Ohio, don’t drive with a dog in your lap.  Determined to stop distracted driving, the police are aggressively issuing tickets to curb behaviors such as driving with an animal sitting in your lap or texting.  All around the world, new laws are being written to address distracted driving.  It is also important to not let various happenings distract us from accomplishing important plans of life.  That includes plans about your finances – financial planning and investing for the future.  We all know from experience that life events can get in the way of advancing forward with best laid plans for the future.  Nevertheless, keeping plans and goals in our foresight provides better chance to achieving them.

The month of May was distracting to investors following 4, back to back to back to back, strong performance months to start 2019.  The S&P500 declined -6.4% adjusting the year-to-date total performance to +10.7% (down from +18.2% through April 30).  Globally, all risk assets corrected due to a sudden breakdown in trade negotiations between the US and China; fears of a prolonged trade dispute could further soften global and US economic growth.  Remember, we wrote in several prior commentaries, that “tariffs can shake the markets,…”  Indeed, May validated that idea again (first shake was January 2018 – see chart to right).  The recent market adjustment was significant enough to suggest that the May 3 market high will be difficult to surpass without resolution to the current trade tensions.

Recall also our April commentary was titled “4 For 4”, sharing that 15 historically rare “4-peat” fast start years occurring since 1950 went on to provide an additional +10% average return for the final 8 months of those years, though there was usually a pullback of -8% on average along the way.  Also, we wrote about the unusual chart pattern occurring during the start of 2019 – a “V” shaped pattern, coming down from late September to Christmas Eve, then rebounding to May 3.  Normal corrective chart patterns are “W” shaped (down, up, down, and up).  We call attention to these 3 concepts at this time – “tariffs will shake the market”; “4 for 4” starts; and “V” shaped chart patterns – because the stock market is seeing them play out concurrently.  It’s happening!  The “V” shaped chart pattern may be evolving into the “W” from the May market decline, supporting historical performance data relating to fast 4-month starts but needing to experience a pullback at some point during the balance of the year.  The catalyst for this is tariff talk which is shaking the markets.  Interesting?!!

Another quick thought about these 3 concepts that are coming together: as we wrote on a couple of them more than once.  Now, they are unfolding together after some passage of time.  For an investor, it’s like putting together jigsaw puzzle pieces without a box lid to provide what the picture looks like.  Thus, investing often involves patience, which can be a difficult exercise for most anything in life.  That includes achieving personal financial goals/plans – it takes time.  Undistracted patience is required.

It is often said, “Economic expansions don’t die of old age – they get murdered.”  As we start June, this US economic cycle ties the longest 10-year running economic expansion (in July, this expansion becomes the longest running on record; the former longest was March 1991 to March 2001).  The most common cause of “death” of an economic expansion is inflation and the Fed’s over-zealous attempts to curb it.  Other causes are generally derived from some other “policy mistake” – fiscal, regulatory or trade, or an outside event (like oil embargo of 1973).  In the 1930s, the US “policy mistake” took 3 concurrent forms – Fed tightened monetary policy; fiscal policy (raising taxes); AND the US engaged in a trade war.  As hindsight is always 20-20, it’s not difficult to see why a 13-year depression occurred.  Policy mistakes can murder the economy.

Today an extended global trade battle requires close attention – daily market activity can provide some of those signals.  A prolonged trade dispute with China, and now an additional tariff threat with Mexico to address immigration, creates a lot of economic uncertainty.  Economic uncertainty occurs because business leaders postpone decisions to hire or invest in plant and equipment because they are uncertain how tariffs will be resolved.  Thus, business confidence is under pressure.  The typical US consumer may not know or care much about trade issues with China or Mexico, but they care about prices.  Consumers may react to higher prices by cutting back on their buying plans.  In general, tariff issues are distracting the “driving” of the US and global economy.

Initially, tariffs are viewed by economists as inflationary – higher prices for those items where the tariff tax is levied.  Longer term however, tariffs are deflationary and economically contractionary.  As businesses and consumers alter normal spending plans the underlying economic environment slows.  If prolonged with too heavy a tariff load, a growing economy could slide into a recession.  But, recession thoughts are too extreme at this point.  Presently, the US economy is strong enough that the base economic outlook is “muddle through.”

Investors are also watching the Fed.  While the Fed suspended their plans to raise interest rates in early January, the slowing economic landscape in the US and globally is key to recent financial market worry.  That fear is evident in the bond market.  Market action in May is putting significant pressure on the Fed to modify their “pause” policy, to “ease” or lower interest rates.  The Treasury yield curve is inverted again – short rates are higher than 2-year and 5-year rates.  Meaning, a “policy error” may be developing because the Fed is deemed slow to adjust.  Again, delayed tariff resolution with China is slowing US and global economic growth, and the steady interest rate policy by the Fed is now deemed too tight and could further slow a “muddle through” economy to an even slower pace.  Markets are instructing the Fed, “Lower rates, or the economy will stall” because of tariff uncertainty.  [Tuesday 6/4, Fed Chairman Powell indicated it will “act as appropriate to sustain the expansion;” they are paying close attention to the effects of tariffs on the economy.  Guess what?  The market jumped higher on the news.]  Lower interest rates are now a possibility.

We are pursuing a “dialed down” risk tactical strategy in all client portfolios.  That does not mean altering the stock/bond investment objective.  It means we dialed down the risk-structure of both stock and bond exposures over the past year.  We did this by tactically reducing exposure from more risky higher-priced areas of stock and bond world, and emphasizing lower risk, lower-valuation areas.  This is providing value to client portfolio performance.  This strategy was employed because of the current challenging political environment and because the current Bull market is 123 months old (longest running).  Yet, if the economy can weather tariff uncertainty, if the markets can be supported by appropriate Fed policy action, markets can avoid possible policy mistakes that cause the economy to contract.

Patience is encouraged (it takes time for events to unfold and evolve).  Focus on the longer goal is important.  In other words, remaining undistracted about your goals requires staying on a planned spending path; regularly saving; and utilizing diversified investment practices.  “Time in the market” is one key principle to long term investment success.  The market adjustment in May could be the “pause that refreshes” as this current Bull market rests a moment before enjoying time to run again.  Maybe 2019 becomes a 16th example of strong calendar year market performance after starting “4 for 4”.

“I learned early in sports that to be effective – for a player to play the best he can play – is a matter of concentration and being aware of distractions, positive or negative.”  Coach Tom Landry (Dallas Cowboys)

Author: Bill Henderly, CFA – June 5, 2019
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