On the Horizon: Still Climbing That Wall of (China) Worry | Second Quarter 2019
In a nutshell: Investors always have a laundry list of market related concerns, but there are typically a few dominant issues that are likely to determine investment activity and results over the coming months. Chief among that list continues to be global economic growth, negotiations between the United States and China on a trade deal, and the actions of the U.S. Federal Reserve. The latter two provided major market moving developments during the 2nd quarter and are likely to remain front and center as the year progresses.
Global Economy, China, The Fed, Inverted Yield Curve, and Washington, DC: On the Horizon
There are typically some themes, data points, and scheduled events that can reasonably be expected to impact markets. And though unanticipated events always occur, we address the more probable or predictable ones below. We also attempt to gauge what the market may be anticipating given that markets place their bets ahead of actual announcements or resolutions based on what the market believes the likely outcome will be. Therefore, market reaction is often more a result of how different the actual result was from investors predictions.
- Is recent softness in economic data transitory or a more worrisome signal? Global economic growth is always a concern for investors, but with recent data showing some signs of slowing activity it is likely to be an even greater focus. Periods of slower activity over the course of the current economic expansion have so far proven to be temporary, but investors are always on the lookout for any signs of the next global recession. Continued discussions of inverted yield curves and trade wars only add to the concerns caused by the recent data. Global bond markets may be priced for economic weakness, but equities are clearly not as evidenced by the strong year-to-date returns and many U.S. indices reaching all time highs.
- Will the U.S. and China ever reach a trade deal? On May 5th of this past quarter, President Trump tweeted that not only was a trade deal with China not likely, but that he was prepared to up the ante by introducing additional tariffs. China quickly followed suit with additional tariff threats of their own. In a matter of just a few tweets, the narrative on a potential trade deal between the two superpowers had completely changed. Investors and markets had begun to assume that a deal would eventually come to fruition and when it became clear that discussions had stalled, markets reacted negatively. Fortunately, weakness was short lived, as markets stabilized and eventually recovered despite no clear indication that a deal was imminent (Update – the two countries agreed to not impose new tariffs and to resume discussions after a meeting at the G-20 summit in Osaka, Japan on Saturday June 29th). One positive from the past quarter’s development is that investor expectations are now much lower as they no longer presume a deal is imminent or even inevitable.
- Where does the Fed go from here? At the tail end of the 1st quarter, the Fed made a significant change in its language and outlook. They reduced their economic growth expectations and signaled their intention to hold interest rates steady. Never satisfied with leaving well enough alone, investors quickly began to speculate that the next rate move would be a reduction and it could come as early as their June meeting. This speculation proved false as the Fed decided to hold rates steady, but the expectations for rate cuts in 2019 remains. While market expectations grew more pessimistic on a U.S. / China trade deal, the opposite is now the case with regard to the Fed. Markets are now fully expecting at least one rate cut, if not more, in 2019 which raises the risks to market prices should those cuts not occur.
- What does the inverted yield curve signal this time? Lost in the focus on China and the Fed is the fact that the U.S. yield curve has only become more inverted over the last few months. While there are some rational reasons to think that an inversion of the yield curve may not be as reliable of an economic indicator as in the past, it should still not be ignored. From a practical standpoint an inversion reduces the profitability of bank lending which can restrict credit growth and activity in the broader economy. Investors may have been preoccupied with China and the Fed the past few months, but with the 10-year U.S. Treasury yield at just 2% and an inverted yield curve a reality, it would be surprising if it didn’t garner more attention going forward.
- What, if anything, will Washington D.C. focus on now? What list of market moving possibilities would be complete without some comment related to our nation’s government. While Mueller Report-related inquiries are likely to continue, it is unclear to what end. A few Democrats have called for impeaching President Trump, but there appears to be little current support for that path among party leadership. Instead, attention appears to be shifting to the 2020 Presidential campaign with the Democratic Party recently hosting two nights of nationally televised debates. It is probably too early to expect those debates to have much market impact, but should a frontrunner for the Democratic party emerge, their proposed polices and ideologies could shift investment views around particular industries and foreign relations. The good news is that when it comes to politics, investors have become somewhat numb to all of the bickering and posturing.
Last quarter, we listed among our concerns the ongoing Brexit saga. It is not listed this quarter, but that is not because the issue has been resolved. Rather, the proverbial can has been kicked down the road until the latter half of 2019. Teresa May has resigned as the Prime Minister, but new leadership doesn’t mean that future Brexit negotiations will proceed smoothly. We fully expect this issue to reappear on the list later this year.
Investor sentiment shifted several times over the course of the quarter. The positive sentiment and strength of the 1st quarter continued through April and into early May. As discussed in our market recap section, things changed abruptly on May 5th with one very pointed tweet from President Trump. Markets reacted negatively over the following weeks, but did stabilize. They were even resilient enough to withstand a short spat with Mexico in late May, in which tariffs were again used as a bargaining tool. As important as the Fed and inflation readings may be, markets are likely to be hyperfocused on China trade talks and whether or not the tariffs in place or proposed could be enough to tip the global economy into recession.
Contact Brad Swinsburg 404-874-6244 for more information on the dominant issues most likely to impact investor activity and results over the coming months.
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Unless stated otherwise, any estimates or projections (including performance and risk) given in this presentation are intended to be forward-looking statements. Such estimates are subject to actual known and unknown risks, uncertainties, and other factors that could cause actual results to differ materially from those projected. The securities described within this presentation do not represent all of the securities purchased, sold or recommended for client accounts. The reader should not assume that an investment in such securities was or will be profitable. Past performance does not indicate future results.