Market Commentary - 06/19

After sprinting to a 25% advance from the late December 2018 lows to a new high of 2945 on the S&P in early May, led again by the tech/growth complex, the market faded by ~5% in May.  The culprit was a rapid escalation in trade tensions with China as 25% tariffs were placed on $200B of China’s exported goods and negotiations were halted.  There was also a spillover into the all-important tech sector as the US imposed restrictions on Huawei’s component sourcing capabilities.  This trade turmoil soured investor sentiment, and the idea that a deal is coming is much less certain.  Some hope remains as the US and China will attend the G20 summit at the end of June.  A further escalation with another round of tariffs is likely to be even more problematic as those levies would be imposed on more consumer goods.  This would hurt personal spending that accounts for 70% of the economy.  As it stands now, the situation is creating uncertainty for capex spending, but consumers paying higher prices for goods would definitely dampen economic growth by some order of magnitude.

The slowing global growth theme remains firmly in place as well – China’s April data turned down, Europe is facing a messy Brexit ordeal and stagnant growth, and some recent US data such as retail sales, May jobs, PMI data and durable goods orders suggest our economy may be fading, despite historically low unemployment at 3.6%, real wage and productivity gains, and a very strong Q1 GDP print of 3.1%.  JP Morgan recently cut their GDP forecast for Q2 from 2.2% to roughly 1%.  Still a positive metric versus a very tough Q2 comp from last year (+4.2%), but fading growth prospects probably won’t push the S&P much higher than 2900.

This has become a headline-driven stock market that currently feels stuck between 2800-2900 on the S&P.  There are plenty of downside risks swirling as many sectors/markets fell into correction territory in May while utilities and REITs outperformed.  A further drop in the yield curve with the 10-year US Treasury fading to ~2.0% in early June is perhaps another negative signal for economic growth prospects.  This is stirring up more debate about the Fed’s ultimate course for interest rates.  While rate hikes are off the table now, a cut may be increasingly likely according to many market observers, although the Fed has not yet indicated that is likely. 

While the global growth picture has deteriorated and taken some air out of the sizable YTD rally, the broad market is still up ~14% in 2019 and the likelihood of a meaningful recession remains low at this point.  The recent pullback to 2865 means the S&P trades at a 16x P/E multiple, assuming ~$180 for S&P EPS in 2020.  Therefore, the market is not overly expensive, unless the E in P/E proves to be too high.  Corporate buybacks, a dovish Fed and scant returns from bond markets are likely to buoy equities, in our view.  President Trump is also heading into an election cycle and doing something to undermine the progress of the US economy would not be wise if re-election is his goal.  As a result, we are prepared for a more volatile, choppy market and seeking opportunities to deploy capital.