Weekly Market Update (August 05 – August 09, 2019)

By Craig Fehr August 16, 2019

U.S. stocks finished the week modestly lower, and bond yields fell to their lowest level in three years, while volatility remained elevated because of escalating trade tensions between the U.S. and China. Global markets reacted to an unexpected drop in the value of China's currency, which was viewed as a retaliatory response to the recently announced tariffs on Chinese goods scheduled to take effect in September. Chinese officials later sought to reassure markets that they don't plan to embark in a currency devaluation campaign, calming investors. Our view remains that some form of an agreement or compromise can and will be reached, but not soon. The back-and-forth trade tactics will likely continue to stoke market volatility and pullbacks as we advance. However, we think the outlook is still positive based on resilient economic expansion, modestly rising corporate profits, and still-low interest rates.

Going to Need a Bigger Boat?

"Pete and Repeat are in a boat. Pete jumps out. Who's left?" Children have been using that one to drive their parents mad for years. The markets have been stuck in the same boat for over a year as well. Trade tensions, an inverted yield curve, market volatility, and repeat are in the boat. The first three have periodically jumped out, but you-know-who is left.

These familiar themes had their hands on the oars again last week, with the latest flare up in the U.S.-China trade saga and a notable drop in interest rates combining to send stocks lower. Stocks and bonds have both done well this year. The S&P 500 was at an all-time high just two weeks ago, and bonds are on pace for their best year since 20021 as the Federal Reserve has pivoted to a more accommodative policy stance.
But the stock market just endured its worst day (last Monday) of the year, and the Dow averaged intraday swings of 460 points over the past week, reflecting rising anxiety that, this time, there might be a leak in the boat. With market volatility making a comeback, we'd offer the following three takeaways:
  1. The trade war waves won't subside soon, but they shouldn't capsize the economy. The trade spat between the U.S. and China continues to ebb and flow, with tensions escalating last week as the Trump administration's announcement of new tariffs (potentially slated to go into effect in September) were met with a different response -- Chinese policymakers allowed China's currency (the yuan) to depreciate to the lowest level in more than a decade. Markets found some comfort as Chinese officials took measures to stabilize the yuan, but with the latest tariffs aimed largely at $300 billion of consumer goods (apparel, phones, electronics, etc.) and China retaliating with a broader currency tactic (a devalued yuan makes Chinese exports cheaper and U.S. exports more expensive), this signals to us that the trade tensions are likely to continue to boil. Ultimately, however, we don't think trade will spark an impending collapse. Exports amount to roughly 12% of U.S. GDP, compared with consumer spending, which accounts for nearly 70%. With unemployment likely to remain near historic lows and wages firming, we believe the U.S. economy can continue to grow at a reasonable pace despite weakness in trade. Further, with trade comprising a larger component of China's economy and a presidential election just over a year away, we think an eventual compromise can be reached, as both sides have a vested interest in supporting economic growth.
  2. Falling rates reflect headwinds, but the yield curve isn't a beacon of inevitable trouble. Last week, 10-year interest rates fell below 1.7% for the first time in three years, refueling worries that an inverted yield curve (when long-term rates are lower than short-term rates) is signaling an approaching economic storm. Falling long-term rates are a cautious signal that should not be dismissed, as this reflects a growing market view that economic conditions are sailing into a recession. While this can be a reliable signal, it's not watertight. While we agree that the economy faces headwinds, most recession indicators are not flashing. We think the kneejerk market reaction that trade challenges will spark an upcoming downturn are overlooking other underlying economic trends that should support ongoing moderate expansion. Further, the drop in 10-year yields also likely reflects expectations for further Fed rate cuts, not just a dwindling growth outlook. Though we think the market may be pricing in steeper rate cuts, the broader conclusion is that the Fed is taking a supportive policy stance, not a restrictive one (which is a typical hallmark of the end of the cycle). Put simply, last week's falling rates acted as the tail that wagged the dog, with equities dropping in response to the decline in yields. But lower rates (be it longer-term rates or Fed rate cuts) are also an input to the economic engine. To the extent low rates offer support to the economy, this is broadly supportive for the stock market over time.
  3. A three-hour (de)tour? We've sailed these currents before. Last week's sizable swings and headline-grabbing daily drops are not indicative of the wider seascape.
    • For starters, a look at the horizon shows that the U.S. stock market is just 3% below the record high set in late July and is still up nearly 18% this year, which would make this the third-best yearly gain over the past 10 years2.
    • Moreover, balanced portfolios don't just mimic the Dow. So while the recent market pullback is capturing a lot of attention, the level of attention is not necessarily commensurate with the magnitude of the market move, as diversified portfolios have not experienced the same swings.
And, importantly, we are not in uncharted waters. Trade fears have surfaced frequently, as have worries over the yield curve/falling rates. In each instance, the market reacted in similar fashion, pulling back initially before reconnecting to the broader fundamentals. But these past cases caused the market to only periodically veer off course, not run aground.

Weekly market update image 8-9-19

So what should investors do now? First, don't jump ship. It's far more difficult to reach your financial goals if you're swimming versus sailing. There will come a time to batten down the hatches a bit as a recession emerges and the bull market cycle is exhausted, but we don’t think those conditions are looming. Second, get a bigger boat. Cruise ships are less battered by waves than canoes. In this case, a bigger boat isn't about portfolio size. It's about having a portfolio that is properly balanced and diversified. You wouldn't load all your cargo on one end of your boat because you'd raise your risk of tipping when conditions get choppy. Similarly, make sure your portfolio isn't overloaded to one side by rebalancing your equity/fixed-income blend and allocating your investments across an appropriate combination of asset classes.

Craig Fehr, CFA
Investment Strategist

Sources: 1. Bloomberg, total return of the Barclays U.S. Aggregate Bond Index. 2. Bloomberg, total return of the S&P 500

Index Close Week YTD
Dow Jones Industrial Average 26,287 -0.7% 12.7%
S&P 500 Index 2,919 -0.5% 16.4%
NASDAQ 7,959



MSCI EAFE* 1,840 -1.3% 7.0%
10-yr Treasury Yield 1.74% -0.11% -0.95%
Oil ($/bbl) $54.43 -2.2% 19.9%


$111.95 0.9% 6.9%

Source: Bloomberg, 08/09/19. *5-day performance ending Friday. Bonds represented by the iShares Core U.S. Aggregate Bond ETF. Past performance does not guarantee future results.

The Week Ahead
The second-quarter earnings season will continue to wind down next week with less than 3% of companies in the S&P 500 reporting results. Economic data being released in the U.S. include inflation on Tuesday, retail sales on Thursday, and consumer sentiment on Friday.

Important Information

The Weekly Market Update is published every Friday, after U.S. markets close.

The Dow Jones Indexes are proprietary to and distributed by Dow Jones & Company, Inc. and have been licensed for use.

All content of the Dow Jones Indexes © 2017 is proprietary to Dow Jones & Company, Inc.

The Dow Jones, S&P 500 and Barclays Aggregate Bond Indexes are unmanaged and are not meant to depict an actual investment.

Past performance does not guarantee future results.

Diversification does not guarantee a profit or protect against loss.

Investors should understand the risks involved of owning investments, including interest rate risk, credit risk and market risk. The value of investments fluctuates and investors can lose some or all of their principal.

Special risks are inherent to international investing, including those related to currency fluctuations and foreign political and economic events.

This information is approved for use with the public.

It is intended for informational purposes only.

It is believed to be reliable, but its accuracy and completeness are not guaranteed.

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