Down but Not Out
After finally making new all-time highs in late April, the US stock market pulled back during the month of May, declining over 6% while bonds increased over 1%. The impetus for the decline has been largely due to the re-emergence of trade disputes between the U.S. and China. After China allegedly reneged on some key provisions of the trade agreement, the US administration quickly increased the tariffs from 15% to 25% on various products imported from China. The implications of a long, drawn out trade disagreement concerned the markets, and a slow but steady decline in the stock indices emerged after four months of solid gains.
This concern centers around the increasing possibility of a slow down of global growth should the U.S. and China not come to another agreement, which would cause market participants to re-price stocks with the prospect that earnings will slow down as a result. While we’re not overly concerned at this time, there is reason to be cautious and attentive to how this story develops. We have been here before, with the market sliding on global growth concerns, but have also seen the market snap back on the slightest hint that an agreement is forthcoming. This may still hold true, but in the meantime, we anticipate a pickup in volatility as the negotiations continues to unfold.
The other re-emerging concern is surrounding Europe and Brexit. This event has been going on for years, but more recently has begun to reflect more uncertainty. However, the U.S. economy continues to show its strength, particularly relative to the rest of the world. The potential for an earnings slowdown in the U.S. is certainly on the table — particularly as costs from the increase in tariffs of Chinese goods finds its way into future corporate earnings results. However, U.S. companies have been stymied by this potential for higher cost for some time now and are better positioned to gradually offset the negative effects given the time they’ve had to prepare for this possibility.
U.S. corporate earnings in the first quarter had widely been better than expected, and with earnings season almost behind us, the market will be forced to focus on these external, geopolitical events to drive the direction of the market. This, too, will likely increase volatility, as the daily barrage of news, both good and bad, will impact the markets to a greater degree without having a source of fundamental data (ie: earnings) to balance out the geopolitical banter.
Even with the recent pullback, the broad market indices are still well into positive territory YTD, though it is a little discouraging that the S&P made new all-time highs for a few days before retreating and unable to sustain these highs. Through a technical lens, this implies that the new highs were not able to be held and that there may be more choppiness ahead, as the market determines whether it can maintain a level close to new highs or will retreat further.
Rest-assured, we are already well positioned to weather increased volatility through small adjustments we’ve been making throughout the year. During the late stages of the economic expansion cycle, volatility does typically pick up, and investors are more selective in what companies they buy – generally lower risk, higher quality and less speculative issues hold up more favorably. With a healthy position in a minimum volatility fund, as well as exposure to quality stocks, we’ve reduced our equity exposure away from a purely market cap weighted index methodology. This should help weather what we anticipate to be a sideways market during the summer months, punctuated by lower than normal volume and a some whip saw action in the day to day market movements. We will continue to observe how this plays out and will be on high alert.
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Because the information on this blog are based on my personal opinions and experience, it should not be considered professional financial investment advice. No financial decisions should be made based off this article without consulting with your financial advisor first.
