Investment Insights: Stocks aren’t a sinking ship

Wade Balliet
Posted by Wade Balliet
Investment Strategy

This weekly report presents insights from our Global Investment Management team.

Stocks plunged in trading on Monday after new rounds of escalation in the ongoing trade war between the U.S. and China.

The S&P 500 fell 3.0% and the Dow tumbled almost 800 points yesterday before recovering today as cooler heads prevailed.

After President Donald Trump announced a new 10% tariff last week, China retaliated by halting imports of all U.S. agricultural products, and may have devalued its currency in an effort to offset the duties and increase exports.

The Chinese yuan fell against major currencies, and passed the psychological threshold of seven yuan per U.S. dollar – its lowest level since the financial crisis. There doesn’t seem to be any end in sight for this trade war. The conflict has already begun to spill over into international policy and now has the potential to also become a currency war.

Rattled investors flocked to safe haven assets amid the heightened volatility, lifting prices in gold and Treasuries. The 10-year Treasury yield sank to 1.71% on Monday as yields across the curve declined. If bond investors thought the market might be flashing warning signs before, those signals are even more obvious now.

The continued inversion in the Treasury yield curve deepened as a volatility-driven buying spree dragged yields to the most extreme inversion since 2007. The 1-month Treasury is now yielding a whopping 0.51% more than its 5-year counterpart. While the Fed may have been on the fence about shifting toward dovish policy, the drop in longer term yields has provided further justification for more aggressive easing. Fed funds futures are now pricing in a 25bps rate cut at each of the three remaining Fed policy meetings this year.

Corporate earnings are still flying under the radar when compared to the unpredictable events within geopolitics and monetary policy, but that may also be due to results being mediocre at best. So far, 413 companies of the S&P 500 have reported earnings, and as we had predicted, earnings growth is modestly positive at 1.55%, according to Bloomberg. The most recent report from FactSet shows that if the remaining companies meet estimates, aggregate earnings growth will be -1.0% for the second quarter. However, we have previously mentioned that individual outperformance is probable, and we believe earnings will likely remain marginally positive – not exactly a strong support for stock valuations.

While we haven’t been crying wolf over recession fears or a market correction, our team continues to view risks as skewing toward the downside for financial markets. We maintain our forecast for a potential economic slowing in the latter part of this year and into 2020, which should mean corresponding movement in the stock markets. Our strategies remain relatively defensive in the current environment, and our recent allocation adjustments should contribute positively to our performance. We don’t see this recent volatility as the beginning of the end, though we may see similar days ahead. Investors will likely need a more tangible catalyst before markets start on a lasting selloff.

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Investing involves risk, including the possible loss of principal and fluctuation in value. Economic and market forecasts reflect subjective judgments and assumptions, and unexpected events may occur. Therefore, there can be no assurance that developments will transpire as forecasted. The information in this newsletter is for informational purposes only and is not intended to be investment advice or a recommendation. Nothing in this newsletter should be interpreted to state or imply that past results are an indication of future performance.

Fixed income securities are subject to interest rate, inflation, credit and default risk. The bond market is volatile. As interest rates rise, bond prices usually fall, and vice versa. The return of principal is not guaranteed, and prices may decline if an issuer fails to make timely payments or its credit strength weakens.

International securities involve additional risks such as currency fluctuations, differing financial accounting standards, and possible political and economic instability. These risks are greater in emerging markets.

Diversification and asset allocation do not ensure a profit or guarantee against loss.

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