May 2019 RecapMarket Commentary |
Equity markets turned sharply lower in May as the S&P 500 declined by -6.35% – the worst May return since 2010. Despite the monthly decline, the stock market is still up 10.74% in 2019. The S&P reached an all-time high on May 1st due to some better than expected economic and corporate earnings data and progress toward a US/China trade deal.
In our last monthly piece, we discussed the importance of staying the course. The market was off to such a strong start to 2019 that we believed the pace could not continue (the S&P was on track for its best calendar year ever by a wide margin). We also established that “Sell in May and Go Away” has historically been a losing market timing strategy and should not be considered as a serious investment approach (although admittedly the strategy would have worked well in 2019 for now).
In our writings and conversations with clients we always stress the importance of maintaining a long-term viewpoint and the power of combining a comprehensive financial plan with a structured, consistent, and repeatable investment process. We continue to believe this is the best approach for helping our clients navigate through financial markets and ultimately reach their goals and objectives.
May 2019 included several important market events. Part of the yield curve inverted again as the spread between the 10-Year Treasury minus the 3-Month Treasury yield ended the quarter at -22 basis points. Please see our Q1 2019 Market Recap and Outlook for implications and analysis of a yield curve inversion. Interest rates declined throughout the month as the 10-Year Treasury yield dropped to 2.12% – the lowest level since September 2017. The decline in interest rates pushed bond prices up as yields move inversely to prices. On May 30th, President Trump unexpectedly announced the US intends to implement 5% tariffs on all imports from Mexico effective on June 10th (the rate will rise by 5% every month thereafter until it reaches 25%). We will have more on the US/Mexico tariffs in the future as the issue is still developing.
In our opinion, the key event in May and the primary reason for the market turmoil was the negative development in the ongoing US and China trade war. Just when it looked like the two sides were approaching the finish line of a comprehensive trade agreement the negotiations took a few major steps backward. After the latest round of discussions in Beijing at the end of April, investors hoped a trade deal could be signed within a few weeks. However, on May 5th President Trump tweeted that China had reneged and were attempting to renegotiate key aspects of the agreement. As a result, the US raised the tariff rate on $200 billion worth of Chinese goods from 10% to 25%. The US also threatened to implement 25% tariffs on the remaining ~$300 billion worth of Chinese imports. China immediately responded by increasing the tariff rate on $60B worth of US goods starting on June 1st. To update the scoreboard, the US has implemented 25% tariffs on $250B worth of Chinese goods and China has placed 5-25% tariffs on $110B worth of US goods.
The main issue in the conflict appears to be evolving from trade deficits to technology. In May, President Trump signed an order granting the Commerce Department power to ban US companies from buying foreign telecommunications equipment. The Commerce Department also banned US companies from selling to Huawei Technologies, China’s largest telecom equipment manufacturer, before announcing a handful of 90-day exceptions. Huawei has subsequently filed a lawsuit in a Texas court that challenges the restrictions. The proposed ban came about six months after Huawei’s CFO was arrested in Canada at the behest of the US on charges of violating economic sanctions against Iran. Further reports also suggest that the Commerce Department is considering adding several Chinese surveillance companies to their restricted list while limiting US exports of quantum computing, robotics, and artificial intelligence. As of now, it is unclear if the actions by the Commerce Department are part of a negotiating ploy for the overall trade agreement. China has also yet to respond with similar penalties on US companies.
The trade war is major issue due to the potential negative impacts on economic and corporate earnings growth. The Federal Reserve Bank of New York estimated that the current tariffs will cost the average US household $831 per year due to higher prices and reduced economic efficiency. The current consensus estimate for 2019 United States GDP growth is +2.6% year-over-year. Bloomberg estimates that the current tariffs will decrease US GDP growth by -0.2% (-0.5% if the US implements 25% tariffs on all Chinese goods.) The current consensus estimate for 2019 S&P 500 earnings growth is about +4% year-over-year. Goldman Sachs estimates that current tariffs will decrease S&P earnings growth by -2% (-6.0% if the US implements 25% tariffs on all Chinese goods). Several companies have also stated they will raise prices, accept lower margins, or shift their supply chains out of China in response to the increased tariffs.
As of month end, there is no official meeting scheduled between the US and China to continue discussions. However, reports suggest that President Trump and Chinese President Xi will likely meet face-to-face at the G20 Summit in Japan at the end of June. Trump and Xi last met in person at the G20 Summit in Argentina in December of 2018 and were able to agree to a temporary trade war cease fire. While it is impossible to say exactly how the trade negotiations will play out, as the situation is very fluid and can change on a tweet, both sides have a lot to lose from the resulting economic weakness. As we’ve previously stated, the trade war will remain a stock market risk and a drag on the global economy until an agreement is signed and all tariffs are eliminated. We remain optimistic that cooler heads will eventually prevail as an agreement would be in the best interest of both countries.
Read May 2019 Client Question: How has the S&P 500 historically performed over 10-year periods?
Andrew Murphy, CFA
Director of Portfolio Management
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