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What Did We See?

• The US equity markets abruptly declined in May.
• Tariffs, inverted yield curves and seasonality can be blamed.
• The temperament of the markets have now shifted to the negative.
• Global markets were negative with Asia and Emerging Markets faring the worst.
• The UK and Europe fared slightly better but were still negative for the month.

Where Do We Stand?

• Our equity cycle work has been rather prescient during this most recent period.
• We continue to monitor the recession story very closely but still don’t believe one is imminent.
• We continue to look to de-risk our client portfolios as opportunities to do so present themselves.
• The Fed will continue to remain patient but could alter their stance as the environment dictates.
• We continue to rebalance your accounts accordingly as well.

Global equity markets saw a bit of mayhem during the last month.   Market temperaments that can change on a dime conspired to drive equities to their worst monthly loss since December. From tariffs to inverted yield curves to seasonality (sell in May!), the reasons for a negative month were plenty.  With the S&P 500 losing more than 6%, it was the worst May since 2010 and the second worst since the 1960’s.

Is it different now?

What is different this time?  Every dip in the equity markets over the past several years has come with little to no real issues attached. Certainly there have been “scares” due to one thing or another. However, all of those scares have been quickly quelled with either better economic data or a resolution of the problem that caused the scare in the first place. Thus, all of the dips over the past several years have actually been opportunities to buy more equities at good prices.

Let’s examine what’s changed…

Difference #1: Tariffs and trade wars

Six days into the Month of May investors were informed that the US was going to move ahead with tariff increases on US imports from China. As we came into May the S&P 500 was sitting on an all time high, enjoying the prospects of a trade deal with China.  All of that was changed with this announcement. Treasury yields fell, signaling more than three Federal Reserve cuts by the end of 2020.

On May 10th the US followed through with its promise by increasing tariffs from 10% to 25% on $200B worth of Chinese imports and announcing it may impose a 25% tariff on the remaining $300B of imports. China retaliated, of course, by increasing the high end of their tariff range to 25% on $60B worth of US imports.

Rising tariffs will effect both economies negatively. In the US inflation could take hold which would constrain growth. This in turn could very likely constrain CAPEX (Capital Expenditures) as corporate managers apply a wait-and-see approach to any expansionary plans. This will result in job losses and falling consumer confidence which further constrains CAPEX and the snowball effect is, well, in effect.

Even more troubling is the recent attempt by the president to use tariffs to change a country’s behavior. By applying a 5% tariff to Mexico, the President may be doing more damage to our economy than we know as (Mexico and Canada) are significant trading partners. Mexico is the second largest supplier of goods to the US.

The deeper economic effect here in the US will be lower earnings growth. In fact, the first quarter of 2019 saw no earnings growth over the same quarter in 2018. While this was better than the negative growth that was expected, it still paled in comparison to the 20% earnings growth we saw last year. Lower earnings will mean lower stock prices, unless something changes.

Difference #2: The yield curve

All previous dips in the equity market were accompanied by a healthy yield curve. As discussed in my Quarterly Market Update in March, the yield curve has in fact inverted. However, it is very difficult to time when a yield curve inversion will actually manifest itself in lower stock prices. As I stated back then, “Recession is imminent” is like saying “I will die”. There are truths there to be sure but the length of time it takes to happen is where the real “predictions” can be found. Be wary of prognosticators trying to “time” a recession. They may be right eventually but they also can do irreversible damage to your portfolio.”

This is the first real dip since the yield curve has inverted.

Difference # 3: Seasonality

“Sell in May” is an old adage used amongst Wall Street veterans. This saying came about because of the realization that the best returns in the US equity markets have historically occurred between November 1 and April 30. From 1950 to 2013 the period of May to October has returned about 0.3% average annual while the other 6 months have returned about 7.5% average annual. While this anomaly has not held true the past several years during the current bull market, the statistic is a significant one. Be wary of simple analyses. Recently an analysis of data going back to 1928 found that the period of June through August was the second most robust period for stock returns. As we always say, it is a fools errand to try to time the stock market.

A more reasonable strategy may be to rotate your holdings to more stable investments during the summer months. This is something we have been doing at Shorepine as volatility has increased the past several weeks.

Difference #4: The aging bull

This past March marked what some pundits believe is the 10 year anniversary of the current bull market. 10 years marks the longest bull market the US has ever experienced. They claim a typical bull market lasts about 4.5 years. I claim there are no rules.

Furthermore, I would argue that the bull market didn’t really begin until the previous highs were eclipsed.  That actually didn’t occur until the spring of 2013. Which makes this bull market 6 years old.  That is still a bit long in the tooth but not as dire as the pundits would have you believe.

Where do we stand at Shorepine Wealth Management?

If we go back to my work on equity market cycles we know that we are currently in what is called an “inflationary bull market”. Inflationary bull markets are characterized by “rational exuberance”. There is exuberance during these periods because the prior bear market with it’s “structural unemployment” is over. There is rationality because input costs and interest rates are rising. Other interesting characteristics to note are low participation (average people don’t want to invest), it ends quietly and the cyclical bull periods are strong while the cyclical bear periods are weak. Most of this scenario has come true over the past several years.

We don’t think this secular bull market is as long in the tooth as the financial news outlets would have you believe. While the points cited above may have you believe we have turned “bearish” that is not the case. We’ve been at this too long to know that one poor month or a few bad data points should change our thinking. There are several positive developments that could help this secular bull market get a second wind. If bond yields have truly bottomed that would be a positive. When the earnings picture further stabilizes that would be a positive. If the Federal Reserve were to step in with a rate cut or even the indication of one that would be a positive. When the US and China and Mexico come to a trade deal that would be a positive.

The US economy is still growing. US workers are experiencing unprecedented levels of employment and opportunities. It’s not as bad as the prognosticators would have you believe. We will continue to look for opportunities to de-risk your portfolios but a wholesale exit from the markets is never the answer.

If you have any questions or have experienced any changes in your financial situation please do not hesitate to contact me.

We appreciate your being a part of the Shorepine Wealth Management family and wish you all the best this summer!

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