Ten Years After Lehman’s Collapse
By John Stoltzfus,
Chief Investment Strategist
Ain’t No Cure for the Summertime Blues
As the June and Q2 came to a close, the bears growled louder
At the start of a holiday-abridged week (with the US celebrating Independence Day on Wednesday, July 4), we are reminded that traditionally many traders and investors extend the holiday to the days around the celebration, particularly when it occurs mid-week. This year could bring an exception to that Wall Street tradition due to escalating trade tensions, in particular the July 6 tariff deadline that is looming over US trading relationships across the globe. With the US preparing to level $34 billion in tariffs this week on China, that country has pledged retaliation; meanwhile, Europe, Canada and Mexico are waiting in the wings to adopt their own countermeasures against US tariffs as well. Indeed, on Friday Canada announced that it would impose $12.6 billion USD of tariffs on US products to take effect on Sunday, Canada’s July 1 national holiday.
Will ironies ever cease?
The yield on the 10-year Treasury has moved lower in each of the last three consecutive weeks; this has led to a flattening of the yield curve as the spread between the 10-year and 2-year note narrowed to its lowest level since 2007, adding to investor concerns about the possibility of the yield curve inverting and it signaling a recession in the year ahead or in 2020.
Ironically, the possibility of an actual trade war might divert market participants’ attention from their concerns about this persistent flattening of the yield curve as traders and investors might instead turn to ponder the potential impact on economic growth that a prolonged escalation of hostilities around trade might have (or is even already having) on business and consumer sentiment. A slowing rate of growth for the economy could in effect slow the Fed’s already modest pace of normalization as well as foreign central bankers’ respective normalization activities already in process or planned. (See page 3 of this report for more on our view on the yield curve and what it might be saying lies ahead for the US economy).
“We think there are compelling reasons to suspect that this time a yield curve inversion might not portend to a recession over the medium term.”
The Week Ahead
This week look for Thursday to be the focal point for the markets, when the Fed releases the minutes from its June FOMC meeting. It’s worth noting that last week two Federal Reserve regional bank presidents highlighted that trade friction has already begun to weigh on businesses and is casting a negative pall over the outlook on the economy. Likely, market participants will then turn their attention to Friday’s nonfarm payrolls report for June; Bloomberg’s survey shows a Street consensus average forecast for a 190,000 worker gain with the jobless rate unchanged from the prior month at 3.8%.
When it rains, it pours
The VIX index jumped higher last week, rising 17% above the prior week to just over 16 (see figure below) as worries tied to trade war escalation, higher oil prices (WTI closing last Friday at its highest price since January of 2015) and sundry other issues that highlighted downside risks for economic and earnings growth.
Among the sundry other issues that rattled the market last week was news that Amazon (AMZN) planned to buy PillPack, a Boston-based start-up pharmacy for an estimated $1 billion. The announcement sent PBMs (pharmaceutical benefits managers), and other drug store-related stocks including pharmaceuticals into a tailspin on competition worries.
Added worry for the markets also stemmed from a number of vehicle manufacturers (including GM, Daimler, Toyota and Harley Davidson) that expressed serious concerns about the potential negative effects of increased import tariffs on their businesses. Among the issues cited include that these tariffs reduce their competitive positioning and could even force them to reduce their US presence as manufacturers and subsequently employers in the US. The fact that many major automakers import both some vehicles they sell and the parts they use in manufacturing them in the States is challenging the practicality of the Trump Administration’s process of addressing trade issues that exist between the US and its global trading partners and among its domestic producers.
Musings on the Second Quarter
So far the first half of the year has been a mixed bag for the equity markets stateside and globally.
The US market has shown considerable resilience under pressure through a number of fits and starts and serious challenges in no small part we believe attributable to stateside tax reform, a reduction in regulations, and economic and corporate fundamentals that have yet to show signs of serious deterioration if indeed some slowing.
Corporate and economic data that lies ahead, including Q2 GDP numbers and Q2 earnings season results, could provide some relief from the recent tariff/trade storm near term.
As of the end of the second quarter, the S&P 500, the S&P 400 (mid-caps), the Russell 2000 (small-caps), and the NASDAQ Composite showed positive returns from the start of the year, respectively higher: 1.7%, 2.7%, 7.0% and 8.8%. Among the major indices stateside the Dow Jones Industrial Average was the only one showing a loss in the same period, down 1.8% from the start of the year.
The major International indices, however, all posted losses for the year to date through the end of the second quarter with MSCI EAFE (developed markets ex-US and Canada), the MSCI Emerging Markets and the MSCI Frontier markets respectively off 4.5%, 7.9% and 13.1%.
A good portion of the losses reflected in the returns of the international equity indices reflects the recent strength of the dollar, which reduces gains and increases losses for Americans holding international stocks when performance is translated into US dollars. (See our currency table on page 5 of this report.)
The potential impact of tariffs on foreign stocks has also affected international equities, many of which have a significant exposure to exporting. Slower growth in a number of foreign countries for domestic and regional reasons has also impacted international stocks in the second quarter and first half of the year.
Our expectations remain for some progress in resolving the current trade issues that are negatively impacting these international groups to alleviate the downside pressure seen so far this year. Attractive valuations, longer term cyclical trends as well as secular trends (particularly for the emerging and frontier markets) augur significant opportunity in our opinion for investors willing to exercise patience.
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