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Monthly Market Update - June 2019

May 31, 2019

May’s stock performance took a hit, giving back all of April and even a little more. What caused this? The trade war with China, market breadth and trading activity were all contributing factors. Learn more.

As I reported in May’s Monthly Market Update, April retained its reputation as one of the two historically strongest months for stock performance. Unfortunately Wall Street turned tail for May, giving back all of April and even a little more, also validating May’s long-standing record as one of the two weakest. Barring a solid reversal on Friday afternoon, a fully diversified equity portfolio will have fallen more than 6%, with all major equity categories solidly to the downside. In fact the worst damage occurred within the previously strongest stock group, the semiconductors (the ‘chips’), which is down nearly 15% for May. Close behind were the retailers which, despite some relative strength from Wal-Mart and Target (both positive on the month), managed to drop nearly 11%.

What caused this? I explore below.

Trade war with China

The highest-profile cause for such weakness was of course the sudden reversal of expectations for a trade deal with China, which was further exacerbated by both sides threatening the imposition of pretty major tariffs on important trade categories to try to gain leverage on each other. There is certainly a political divide over the relative merits, or lack thereof, of these tariff threats. Wall Street, however, is one gazillion percent apolitical. It only cares about the true underlying economics.

Nobody should be under any misconception that tariffs aren’t taxes. They are. The larger the tariff, the more onerous the tax. Plus, countries don’t pay taxes, nor do companies, seriously. People pay taxes. Raise taxes on any particular thing and people will consume less of it. It so happens that semiconductors occupy the highest-volume portion of the global technology supply chain, and we all know that a massive percentage of goods sold at retail in the U.S. come from China. It’s no wonder those two groups got hit the hardest.

As this Update goes to the ethereal press on Friday, the new threat to place tariffs on Mexico is putting the cherry on top of the May sell-off, with another 1% to the downside. Auto stocks in particular are getting hit, as a considerable portion of all vehicles – domestic and foreign - sold in North America are finally built in Mexico. Of course, a significant portion of the auto supply chain originates in the U.S., from which those parts are shipped to Mexico for the final auto assembly.

Market breadth, trading activity and more

Even still, causation that drove the markets south in May was hardly contained to issues over trade. Earlier this week I made a list of 23 separate negative market and economic-based data-points and insights that also hit market consciousness. Several were mentioned a month ago in this space, to include market breadth and trading activity which were already quite uninspired even as stocks rose strongly in April.

Several important macro-oriented companies like 3M, UPS and even Amazon and Google had raised concerns in April, coincident with their Q1 quarterly earnings reports, about trending order rates. These were validated in spades by the macro data itself during May. For the first time since I can remember, the Markit PMI New Orders Index showed negligible positive growth. Finally, that near-unanimity of positive sentiment across Wall Street (as per my Ned Davis Conference experience) indeed turned out to be a very negative contrary indicator.

To identify just a few others that resonated with me:

  1. Spot prices of oil and copper dropped like a stone in May – down 14% and 10% respectively. Steel prices – down 9% for May and this is an industry supposedly being a beneficiary of tariff policy. The prices of these vital commodities are clearly reflecting the market’s negative view of future economic growth.
  2. Though not in totality, enough of the U.S. Treasury yield curve has inverted, most particularly the gap between the 3-month T-bill (2.35%) and the 10-year Note (2.18%) has turned its most negative since 2007. This means less and less incentive for banks to lend and us to consume. Not every prior inversion has led to a recession. But every recession was preceded by an inversion, with a lag ranging from 6-18 months.
  3. The Q2 negative pre-announcement ratio, which measures how many S&P 500 companies are indicating earnings projections that are worse-than-officially-forecast for Q2 versus those to the plus side, has surged to 3-to-1, a twenty-five percent jump over the 2.4 in Q1 and compared to a long-term average of 2.1.

Although I introduce this topic with some trepidation, since it indeed can be a ‘third rail’ for analytical discussion purposes, the impact of Presidential politics cannot be ignored. Again (and again and again and again), Wall Street is completely apolitical. It doesn’t care who is in office as long as he/she/they doesn’t do anything economically stupid, i.e. anything that will sustainably reduce macro-economic growth prospects, with the emphasis on the word ‘sustainably’. (Much the better if strong growth-oriented policies can be enacted).

Confidence in, or perhaps it was more likely complacence over, what was in place at the end of April was called into question in May. I can make very compelling intellectual cases for ‘both sides of the aisle’ in this regard. Maybe (and hopefully!) this factor will recede as we finish Q2 and head into Q3. There is no question, however, that politics will roar louder and louder on Wall Street over the next 18 months and it will not be ignored in this space. Please know that I will do my best not to reflect my personal political bias but try mightily to just give you the facts.

What’s in store for June?

So Wall Street enters June somewhat bloodied and perhaps more than a little bowed. This can actually be a good thing for the short term. If I can identify 23 separate negative factors (now 24 with the Mexico tariff threat), so can Wall Street, which has worked very hard to build those (and perhaps a few more) into those considerably lower May month-end stock prices. I am even sympathetic to the idea of a small recovery bounce in stock prices at some point in June, though it could be from lower levels, especially since we all ‘know’ that July is historically the second-strongest calendar month for stock prices.

But I am not going to play for any such rebound. We stand under-weight to target for client equity allocations and we are positioning a greater portion of the equities we do own for our clients more defensively.* As noted last month and the month before, I will happily take positive performance from ‘underneath’. However, though May’s selloff validated many of my concerns, they are far from satisfied. With potential deeper economic issues ahead in 2H’19-1H’20, I like where we stand right now.

Your comments, questions and concerns are always most welcome. I will be back to you with the next Update at the end of June or early in July.

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