June 2019

June Bounce or Trounce?

Market action in May was interesting to say the least. We started off with a record SPX high of 2964.13 on May 1, then broke through the 200-day moving average by month's end for a 7% drop. The long dated U.S. Treasury bond as measured by the TLT-Ishares ETF rose 3.8%. The 10-year Treasury note ended with a 2.16% yield, the lowest since September 2017. 30-year conventional mortgage dipped below 4%.

Deciding within the final hour to take back certain trade concessions, China was swiftly lapped with 25% tariffs on much of their U.S. imports. For good measure, President Trump proposed a 5% tariff on Mexican imports if Mexico chooses not to provide more border crossing assistance.

The Fed is now forecast to cut rates 2 times in 2019, in an attempt to offset a serious economic slowdown. The Fed Funds futures market predicts a 72% probability of a cut at the July FOMC meeting.

Oil fell to a 3-month low in May and continues lower in June, now down over 20% from the spring peak. German 10-year Bunds yield negative 0.23%. Who would accept a negative return on Euros or Yen for the next 10 years? The Japanese sovereign bonds yield is -0.13%. Swiss 10-year yield is -0.52%. The Dutch have just joined the negative club, -0.06%. Can France be far behind?

Most Western governments have 2% inflation targets, yet growth in the Eurozone hovers just above 1%. Money policy in Europe remains accommodative.

Q1 US GDP was revised to +3.1%, however, forecasters at the World Bank see 2.5% GDP for 2019, down from 2.9% last year. China, the second largest economy is slowing to 6.2% GDP versus 6.6% in 2018. World economies are drifting downwards as central banks cling to QE, as long as it takes.

Earnings are still positive, but the rate of growth has dropped considerably from last year's +23% for the SPX.

FactSet noted the following on May 31:

"On March 31, the estimated earnings decline for Q1 2019 was -4.0%. Eight sectors have higher growth rates today (compared to March 31) due to upward revisions to EPS estimates and positive EPS surprises. Earnings Guidance: For Q2 2019, 84 S&P 500 companies have issued negative EPS guidance and 26 S&P 500 companies have issued positive EPS guidance. Valuation: The forward 12-month P/E ratio for the S&P 500 is 15.9. This P/E ratio is below the 5-year average (16.5) but above the 10-year average (14.8)."

It is hard to forecast earnings with conviction, but today's P/E ratio remains in line with the 5-year average. Goldman Sachs forecasts SPX earnings at $173 for the year.

Trade negotiations and tariff increases could add 1.25% to U.S. inflation according to Goldman Sachs. A combination of slowing growth and rising inflation is not very bullish for stocks.

Consumers and employees are happy with 50 year low levels of unemployment and attractive borrowing rates. CEO confidence has waned as uncertainties rise. We are 10 years into this economic recovery and nervous investors shifted dollars out of stocks in May.

Bonds are a safe haven for now, as the environment is stable but slowing. A recession is possible, but not likely in the next 18 months without an exogenous event. President Trump wants to remain in office and a good economy is required. His Chinese counterpart, Mr. Xi needs +6% GDP to retain his power base.

It is most likely we will get a trade deal or two by year end. Continued tariffs would likely lead to weaker equities. Most investors like higher stock prices as does President Trump. An untimely drop and recession in 2020 would hurt his chances for re-election.

Sell in May and go away seems to have worked for investors in 2019. A June bounce has just begun, let's see if can last. Watch government rates for directional clues.

  

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