Staying invested in times of market stress is illustrated here. The chart shows different dates an investor could have switched their portfolio to cash in the late 2018 correction. The outcome that resulted in the highest ending balance was staying invested.
Tariff Start Date Change
Tariffs on consumer products were pushed back to commence September 1st and December 15th for different product categories. To this point, tariffs on China have not been necessarily on broad categories of consumer products as the ones coming up are set to be. U.S consumers would likely notice higher prices should these tariffs go into effect.
The Federal Reserve lowered their target rate for the first time since 2008. Each of the two last times that interest rates were cut, a recession and many more rate cuts followed. This time, the U.S economy is strong on its own but global threats loom overhead.
The next round of tariffs that have been threatened by President Trump will have the most impact on consumer goods.
With little progress being made on ending the trade war, imports of U.S. soybeans by China have dropped to the lowest level since 2004 at just over 5 million tons. To put this in context, China imported soybeans at a rate of 3.2 million tons a month in the first half of 2017.
Strength in Retail Sales
Another sign of strength by the U.S. consumer was revealed in the Retail Sales report showing retail sales rising for the fourth consecutive month. The Retail Sales report covers the durable and nondurable portions of consumer spending and highlighted the broad based spending across categories by the consumer.
Consumers Remain Strong
Consumer spending is estimated to grow at a 4.3% annual rate in the second quarter – the fastest pace since 2014 – according to forecasting firm Macroeconomic Advisers. The U.S. is a consumer based economy – with consumption accounting for approximately 70% of economic growth. The strong growth in spending bodes well for continued expansion in the second half of 2019 and into 2020.
Earnings Forecasts Continue to be Revised Down
Earnings headwinds have been plentiful – stronger dollar, lower oil prices and continued uncertainty regarding trade to name a few. More than 80% of S&P 500 companies that have revised their profit estimates one way or the other in the lead-up to reporting have slashed them, data compiled by Bloomberg show. Analyst estimates now call for a 2.5% drop in earnings for the second quarter. Unless companies exceed analyst earnings estimates, this would mark the first profit contraction in three years.
Economic Data for Eurozone Surprising to Upside
The IHS Markit Eurozone composite purchasing managers’ index (PMI) – used to gauge the direction of economic trends in the manufacturing and service sectors - strengthened to 52.2 in June, up from 51.8 in May, for the Eurozone. June’s PMI reading is the highest level since November 2018, signaling a pick-up in economic growth for the area. Most of the growth was driven by expansion in the services sector; helping to offset the downturn in manufacturing activity that continues to be dampened by tariff threats.
U.S. – China Trade Tensions
Consumer items have largely been spared by tariffs thus far into the trade war. Should the U.S. proceed with imposing tariffs on an additional $300 billion, there will be few items spared as illustrated in the change from current percentage of imports subjected to tariffs on the left to the percentages on the right under the proposed increase in tariffs.
University of Michigan’s Survey of Consumers for June showed that survey respondents voiced concerns over tariffs, which may negatively impact growth and inflation. The 5-10 year inflation estimate from the survey declined to 2.2%, the lowest on record.
Leading Economic Index
The Conference Board’s Leading Economic Index (LEI) level increased to a new cycle high through April. However, annualized growth in the index slowed to 2.7% - the weakest growth rate since 2017. A further slowdown in the rate of improvement bears watching.
U.S. – China Trade Tensions
Trade tensions between U.S. and China have been renewed as the U.S. increased tariffs to 25%, from the previous rate of 10%, on $250 billion of Chinese imports last Friday. Tech-related imports are facing the largest impact from the increased tariffs.
Economic Growth in the U.S.
Economic growth in the U.S. – as measured by Gross Domestic Product (GDP) – beat estimates by a wide margin in the 1st quarter as the economy expanded at an annualized pace of 3.2% for the quarter versus the 2.3% Bloomberg consensus estimate. Contributions to growth were experienced across each major category of GDP.
Rebound In Corporate Earning Revisions
Analysts became extremely pessimistic on their outlook for earnings growth in the midst of the 2018 market selloff; with downward revisions to their earnings growth estimates throughout the fourth quarter. With a majority of companies exceeding estimates for first quarter earnings across the globe, analyst are now revising their pessimism and therefore earnings outlook.
Manufacturing Activity Stabilizes in Asia for March
China led a rebound in manufacturing activity across Asia during March. The IHS Markit manufacturing purchasing managers’ index rebounded to 50.5 from 49.2 for China – the largest increase since 2012. Levels above 50 indicate expansion. Additional evidence is needed to confirm whether or not the economies across Asia are stabilizing.
Economic Growth Cools Down in the Final Quarter of 2018
Fourth quarter GDP growth was revised down from the initial 2.6% estimate to 2.2% as government and consumer spending were less than originally estimated. This final estimate for the fourth quarter brings economic growth for the full year of 2018 to 3%; the fastest pace since 2005.
The Yield Curve Inverts
On March 22nd, the yield on the U.S. 10-year Treasury note dipped below the yield on the three-month paper. While an inverted yield curve often precedes a recession, not all inverted yield curves lead to a recession. Furthermore, while it may be a recessionary signal, it tells us nothing about the timing of such recession. See Legacy’s Insight Piece, “Inversion of the U.S. Bond Yield Curve” for additional commentary.
Market-Projected Rates Diverge from Fed Projected
In February, Fed Chair Jerome Powell reiterated the case for a patient interest-rate policy given “muted” inflation pressures and slowing global growth as a risk to their outlook. The market now expects zero hikes in 2019 relative to the Fed’s projection of two hikes in 2019.
Rekindling the US – European Trade Dispute
U.S. and European differences over agriculture threaten to rekindle a tit-for-tat trade war as Congress and some Trump administration officials are demanding access to European markets following a trans-Atlantic trade truce in July.
Job Openings Rise to a Record High in December
Job openings increased to a record high of 7.335 million during the month of December and exceed the total number of unemployed persons (6.294 million) by more than 1 million positions.
Short-Term Cash Rates Now Yield More Than Inflation
For the first time since 2008, for the first time since early 2008, the three-month Treasury bill has a higher yield than the market’s expectations for inflation over the next 10 years.
Banking System Liquidity & Equity Valuations
In conjunction with the shrinking of the Federal Reserve’s balance sheet, there has been a significant decline in banking system excess reserves. The explosion in banking system liquidity has been noted as a key driver behind the equity market rally since 2009; the subsequent draining may limit equity returns going forward.
Rural America Feeling the Impact of Tariffs
Rural America has suffered a multiyear slump in prices for corn, soybeans and other commodities touched off by stiff foreign competition and a world-wide glut. Tariff retaliation from China, Mexico and elsewhere has further roiled agricultural markets and pressured farmers’ incomes.
BlackRock's "US-China relations" macro risk indicator has been declining.
The synchronized global growth story told throughout 2017 has decoupled as the percentage of countries in expansion drops below long-term average.
Equity Market Selloffs
Sharp selloffs – such as that experienced in the fourth quarter of 2018 – don’t have a great track record as a recessionary indicator.
Federal Reserve Rate Hikes
Rounding-out their 2018 Federal Open Market Committee (FOMC) meeting schedule, the Fed hiked the federal funds rate by 25 basis points (bps) at their mid-December meeting to an upper bound of 2.50%, the fourth hike of 2018 and the eighth hike in their current tightening campaign.
Global Asset Class Performances
2018 has proven to be a tough year for asset classes across the board. With 93% of global assets delivering a negative return year-to-date, 2018 is the worst year on record for this measure.
Stock Market Valuations
The S&P 500 Index’s Forward P/E ratio has hit multi-year lows as it remains in correction territory (down over 10% from record highs).
Companies Ramp Up Buybacks
Shares of several U.S. companies have rallied following recent announcements of increased share repurchases, a welcome development for investors bruised by recent market volatility.
Time in the Market more Important than Timing the Market
While some believe higher volatility brings better opportunities for market timing, such efforts face a high bar relative to just staying invested. Missing the best months in equities, which are often after drawdowns like those experienced in February and October of 2018, lowers holding period returns materially.
Valuation Across Asset Classes have Declined in 2018
Equity and credit valuations are below 1990s average levels again. Equity valuations have de-rated due to a combination of price declines and still positive earnings growth.
Equity vs. Bond Performance
For the first time since 2015, global equities have underperformed bonds in 2018 year-over-year.
Economic Growth Expectations
Economists expect third-quarter gross domestic product (GDP) to come in at a 3.4% annual growth rate this week. If met, this would add up to the best back-to-back quarters since 2014 following the second quarter’s +4% growth rate.
Job Openings Spike to Record
Through August, the number of job openings increased to the highest on record, at 7.136 million. There are approximately 1.2 million more job openings than unemployed persons, potentially indicative of a lack of skilled available labor capital and/or a skills mismatch inherent in the labor force
Earnings Season Could Help Provide Bottoming Process from Recent Selloff
The benchmark S&P 500 index has risen in seven of the past nine earnings seasons, climbing on average 1.7% during the four weeks after big banks kick off the reporting period, according to Dow Jones Market Data. Even more encouraging is that in three of those periods, the S&P 500 had fallen in the four weeks leading up to earnings season. In other words, it’s not unusual for the equity markets to go through a period of weakness before earnings season. With analysts projecting a 21% growth rate in earnings for the third quarter, we expect this trend to continue.
Real Growth Expectations, not Inflation Expectations, Pushing Nominal Yields Higher
Nominal yields jumped on Wednesday with the 10-year U.S. Treasury yield touching 3.23%, a significant 14bp move in a 24-hour period. After retreating slightly, at time of writing yields have moved higher again reaching 3.24%, their highest level since February 2011
U.S. Economy Begins to Disappoint Lofty Expectations
The U.S. economy is growing at the quickest pace in over four years and, therefore, keeps raising the bar for economist’s expectations. The Citigroup Economic Surprise Index, a measure of whether economic reports are meeting projections, has fallen to its lowest level in nearly a year in the U.S. The gauge has dropped into negative territory, indicating releases are broadly starting to come in below expectations. At the same time, we are seeing a rebound abroad where expectations have been depressed.
Economic Growth: U.S. GDP - Quarterly Growth Rate
The U.S. economy grew at the strongest pace in nearly four years during the second quarter. Gross domestic product (GDP) – the value of all goods and services produced across the economy – increased at a 4.1% annualized rate in the second quarter.
In Terms of Returns, however, the Current Bull Market Ranks only 8th
The pure duration of the bull run is impressive but not particularly surprising given the magnitude of the recession that the U.S. has rebounded from. From a return perspective, however, the bull market currently ranks in 8th place in terms of annualized returns.
The Current Bull Market has Become the Longest One on Record
The current bull market began on March 9th, 2009 when the S&P 500 was as 676 points. 9 ½ years and 323 percent later, the S&P 500 officially set the record for the longest bull market run on Wednesday. With double digit earnings growth paired with strong economic growth, there should be room for it to extend this record.
Emerging economies may remain susceptible to appreciating US Dollar (USD)
Trade war concerns, continued tightening of U.S. monetary policy, and more recently an appreciating USD, have weighed on emerging market assets in 2018. Continued USD strength may complicate government funding for those economies that rely heavily on external debt to finance their economy. Across the emerging markets, the IMF estimates that external debt total servicing costs are near 10% of GDP, which, is above long-term average levels, but below peak levels witnessed in 2015
Consumer Spending Remains Strong
With a strong second quarter growth rate, investors are now turning their attention to the third quarter. Retail sales, released last week, provide a good omen with a strong 0.5% monthly growth rate; suggesting consumers remain healthy which should provide continued support for economic growth
Conference Board LEI & Business Cycles
Conference Board Leading Economic Index (LEI) data for June was released last week and showed that the LEI increased 0.5% month-over-month. The index level increased to 109.8 in June, a new cycle high. As the name of the index suggests, this composite of indicators is designed to lead the business cycle, with recent solid growth supportive of near-term economic gains and implying a business cycle still exhibiting an expansionary bias.
Broad strength across all sectors are expected for second quarter earnings season with Energy leading the way.
Rallying oil prices, strong U.S. economic data and buoyant consumer confidence have pushed analysts’ earnings estimates higher since the start of the second quarter.
The U.S.-China tariff war and the S&P 500
Equity markets continue to be conflicted between the benefits of tax reform and the turbulence of tariffs.
Contribution to S&P 500's Gain
Just four stocks have fueled over 82% of the S&P 500’s 2.6% gain on a year-to-date basis through June 30th. Excluding these stocks, the S&P 500 would only be up 0.48%. Excluding the top seven stocks, the S&P 500 would be in negative territory for the year. During an average year, the 10 stocks with the greatest impact typically account for only 45% of the market’s price moves.
US Effective Tariff Rate
The proposed tariffs - if implemented in full - would increase the average effective US tariff rate by about 5 percentage points (pp) and take the US back to levels last seen in the 1970s.
Total US Imports Affected
Counting the tariffs. So far, duties on $55.7 billion of imports have been implemented, including tariffs on washing machines and solar panels, steel and aluminum. A first round of tariffs on $34 billion of imports from China is set to take place on July 6th unless an agreement is reached. From here, President Trump has threatened three further steps: a 25% tariff on an addition $100 billion from China, 20% on $275 billion of auto imports and 10% on an additional $300 billion from China.
June - 2018 Fed Hike Probability
The Federal Open Market Committee will be announcing their next policy decision tomorrow. Another rate hike is nearly fully priced into the markets with a probability of 84%.
Evaluation of Atlanta Fed GDPNow real GDP Estimate For 2018: Q2
The Atlanta Fed’s GDPNow model forecast for second quarter economic growth remains above 4.5%. Even if the model is overestimating growth by 1%, the second quarter is staging an impressive rebound.
Economic Policy Uncertainty Remains Elevated
Politics continue to cause uncertainty and angst for the markets as they dominate the headlines. Most recently, the announcement of new governments in Italy and Spain and the implementation of steel and aluminum tariffs on some of our largest trading partners, including Canada, Mexico and the European Union.
Cumulative Rate Hikes
While the Federal Reserve is increasing interest rates in the U.S., this rate hiking cycle is set to be the longest and shallowest on record.