Market Commentary - June 2019

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S&P Continued Dominance

The escalating trade war with China has gone from a nuisance to a big pain as things worsened over the past month. Still, it has had minimal impact on the performance of the S&P 500. Sure, it has created some volatility but not as much as one may think. Other markets have not faired as well. The S&P 500 is only ~3% off all time highs as of this writing. There will always be periods of time where one asset class outperforms the others. 

Why the discrepancy between the S&P 500 and other indices? Here are my thoughts.

  • Hope - Most are hopeful a deal will get done and the damage will be contained. Hope is not a strategy but markets seem to give the benefit in these types of situations and assume cooler heads will prevail. The issue is both sides seem to have dug in their heels and are blaming one another for the recent breakdown in talks.

  • Interest Rates - Earlier this year, the Federal Reserve signaled it would hold back on rate hikes for the foreseeable future which helped put a temporary floor on markets. The thought is if the trade war continues, the Federal Reserve will cut interest rates and doing so would make bonds and equities more attractive than the alternative (cash, money markets CD's). While this is not always the case, the past five years has pretty much played out this way. The concern is April's slow down came before the latest round of tariffs and if the trade war escalates, additional stimulus and lowering of interest rates will have a minimal impact as the global economy could slip into a recession.

  • Buybacks - This has been mentioned in several of my market commentaries but its importance can't go unnoticed. The tax cut and jobs act significantly benefited corporations who in turn used a majority of the tax savings to buy back shares and/or boost dividends. The numbers are staggering and 2019 is shaping up to be another record year. To put things in perspective, Apple recently announced they would be repurchasing an additional $75 Billion of its own shares. This is in addition to the $100 billion buyback announced in May of 2018. This sort of thing can be part of the reason the S&P 500 seems to bounce back so quickly and continues to outperform other equity markets. While buybacks will continue, the year over year rate at which they are increasing is likely to slow over the coming years which has some worried that the S&P 500 will pay the consequence once this wears off. That remains to be seen but there is no question that buybacks have helped boost US large cap stock prices.

The immediate impact is always hard to identify as it takes time to see the net effect. Some estimates suggest a 0.5% hit on China's GDP and a 0.3% hit to US GDP from the current tariffs in place. While not devastating, this assumes the trade war does not escalate. If it does, the estimates are closer to a 1-2% hit on GDP which would certainly wreak havoc on global markets. It's important to remember the Federal Reserve has less ammunition in its arsenal to fight the next economic down turn as we are in the late stages of this economic cycle and interest rates by a historic measure are still very low. If inflation were to spike, cutting interest rates would backfire as the incentive to lend would diminish as the interest earned would be less than inflation.

While everything above can seem scary, it is not a reason to take action because we could wake up tomorrow with a trade agreement. What an investor should be doing is reviewing their portfolio risk to make sure they are comfortable as this trade war could become another minor bump in the road or the start of the next significant market downturn. No one knows the answer and attempting to guess isn't recommended, so take the time to review your portfolio risk and make sure it is at a level that will allow you to sleep at night.