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June has come and gone and besides the emotional ups and downs it created, it left us with little to be excited about and little to be distraught. The major US indices worked up a good first half of the month with the S&P 500, Russell 2000 and Dow Jones Industrial Average returning 2.84%, 3.14%, and 2.87% respectively; only to reverse course and end the month under 1% or slightly negative Overall international markets stacked more losses to an already negative year-to-date return; meanwhile emerging markets followed their downward momentum, posting another substantial loss of -4.15%. Most likely a suspect to the declines was a still slightly stronger US Dollar1,2.
More tariff talk ensued this month as the Trump administration anted up their threats to Chinese goods and broadened their tariffs to some of our more “friendly” trading partners, namely the EU, Canada and Mexico. But the real focus is the continued verbal and soon to be tariff-implemented battle between China and the U.S. While we continue to see trade tariffs as being impactful, but nowhere close to the benefit of our stimulus package, repatriation, and deregulations, we do want to understand how far we can go on “tit for tats.” A quick comparison of US imports to China imports quickly shows that our bag of tricks is much larger than theirs. Over the last 5 years the U.S. has imported between $318 billion and $375 billion more in good than China has imported of our goods. This creates a clear stopping point where China will have to look at other means to put pressure on the U.S. as negotiations continue. With Trumps recent announcement of $200 billion of more goods to be tariffed at 10%, it’s clear that China will be running out of tricks. We believe it is at this time in which China will have to turn to other means to intimidate our administration (which seems to be a very hard thing to do). One thought would be seeing China restrict visits to the U.S. causing us to lose some visitor consumption power. Additionally, boycotting businesses like Starbucks, would create consumption pain. A last option being coined as the “nuclear option” with China is to have them start dumping the Treasuries they currently own. This, however, would not only be painful for the U.S. but painful for China, and most likely not an option at all. It is all yet to be seen, but one thing is clear…the tariff chest beating will come to an end sooner than later at its current pace and the uncertainty of a true trade war will become more clear3.
On a somewhat more positive note, bank stress testing came back very favorable bringing about dividend increases and share buybacks in the financial sector. This may be a good sign for the financial sector as it continues to battle a flattening yield curve. Valuations today are incredibly low and therefore we remain somewhat cautiously optimistic about our exposure to this sector. With continued regulation improvements, we look for valuations to normalize, bringing market prices back up. Unfortunately the negative technical momentum and the excitement-consuming tech sector are continuing to keep investor interests away from financials4.
And on an even more positive note, the U.S. economy continues to show great strength, despite the worries of the current tariff drag in place. The job’s market hit an unemployment rate of 3.75% in June, which was the lowest it has been since December of 1969; and while the most recent report up-ticked unemployment to 4%, it was actually a positive sign that people were re-entering the workforce as participation increased. Overall our economy looks strong, and certain economists are beginning to project over 3% GDP numbers for the remainder of the year5.
Adding to the positive momentum of this review… stock market valuations (measured by Forward P/E ratios) are now back down to their long-term averages. If we expect market valuations to escalate above their averages before we see a market sell-off, this actually becomes a short-term positive sign for market price growth. To see a market selloff happen when our valuations are already at our long-term average and earnings are continuing to beat expectations would be highly unanticipated and unlikely6. As we move into earnings season, all eyes will be on forward guidance with signs of what companies expect the rest of the year to produce. We believe that fiscal stimulus will continue to drive U.S. equity markets up, especially smaller companies (for more information on this please read our May 2018 Month in Review).
Finally, we go back to the discussion on the yield curve. Historically, when shorter Treasury bills and notes pay more than longer Treasury bonds, it is a signal that the economy is getting hot and we are running close to a recession. However, our research shows that even if you silo-out the yield curve inverting as the only indicator of the economy (which it is not) it’s not merely the “clipping” of inversion that is worrisome, but rather a longer-term hold of an inverted yield curve that could signal a coming recession (think 5 to 6 months of staying inverted). Even then, the typical time between the inversion and the recession can be 1 to 2 years. So while we are closer and closer to an inversion, we don’t believe the day it clips is the day the market dies. Additionally, some question this indicator’s accuracy for this cycle. An inverted yield curve could be looked at as a symptom, rather than the disease, and therefore standing alone as a symptom doesn’t necessarily create a diagnosis. Furthermore, an inverted yield curve actually is helpful to the consumer! When shorter rates are high, people are getting more out of their CDs and when longer rates are low, that means it is costing consumers less to own homes and cars (think mortgage and auto loan interest rates). So the fact that an inversion could happen in the next 12 -18 months may not signal a looming recession or even a bear market7.
Be looking for an invitation soon on our mid-year outlook webinar. We would love for you to join us and have the opportunity to ask us questions you may have!
A reminder, if you have missed any of our Month-In-Reviews you can find them archived on our website at https://www.aghwealth.com/p/month-in-review.
Thank you for your trust and confidence.
LPL Financial Advisor
Vice President, AGH Wealth Management
1 Morningstar Direct™
2 international markets measured by the MSCI ACWI ex US index; emerging markets measured by the MSCI EM index
3 Weekly Economic Commentary, LPL Research, June 25, 2018
5 JP Morgan Guide to the Markets 3QRTR, slide 25
6 JP Morgan Guide to the Markets 3QRTR, slide 5
7 JP Morgan Guide to the Markets call with Dr. David Kelly, July 3rd 2018
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All indexes are unmanaged and cannot be invested into directly. All indicies are unmanaged and may not be invested into directly. The economic forecasts set forth in the presentation may not develop as predicted and there can be no guarantee that strategies promoted will be successful.