Weekly Market Update (June 3 – June 7, 2019)

By Craig Fehr June 07, 2019

Stocks finished the week higher, with the S&P 500 rallying 4.4%, the best weekly gain in six months. At the same time bond yields declined to the lowest levels in two years. Increased expectations of a Fed rate cut, hopes that the U.S. and Mexico can reach a deal to avoid tariffs, and improved valuations, all helped stocks move higher. Economic data were mixed, as strength from the services sector was offset by weakness in the manufacturing sector. Job gains for the month of May came in below expectations, but the unemployment rate held steady at a 50-year low. At this stage of the economic cycle we expect a more balanced mix of positive and negative surprises. However, we continue to believe that resilient economic growth, rising corporate profits, and low interest rates provide a positive fundamental backdrop, modestly outweighing current risks.

Is the Market Teetering?
Depending on where you're from, you likely know the old playground favorite as a teeter-totter or a seesaw. Regardless of what you call it, as children we all enjoyed them just the same.  Pair up with someone of your similar size and weight and the ride was eventful and full of reciprocal ups and downs.  But when the person on one end far outweighed the other, the ride was one-sided.

The market seesaw has experienced both in recent years. From 2013-2015, extraordinary Fed stimulus and falling unemployment provided the weight that persistently held the market up, tipping the scales to a 53% gain over that period. And in 2017, it was the prospect of tax cuts and building economic momentum that supplied the heft to lift the stock market 22% with essentially no teeter to the totter (the year's largest pullback was just 2.8%).

Current conditions have shifted, with much more balance on each side of the market board, as sound fundamental data and increasing policy/trade risks have taken turns bearing the weight of the market's attention. The result has been much more frequent and sizable ups and downs. Stocks fell 19% late last year, followed by a 23% rise through April and tipped down 6% in May1. Based on our assessment, moderate U.S. economic growth, healthy corporate profits, and still-helpful Fed policy are enough to tip the balance in a positive direction more broadly. But trade disruptions and a decelerating global economy are gaining weight. The balance will likely keep the market seesaw in motion as we advance this summer. Here's a look at the key matchups:

  • Jobs vs. Tariffs – Rumors of this economic expansion’s death appear to be greatly exaggerated.  To be fair, the U.S. economy is showing signs of fatigue, highlighted by manufacturing activity slowing materially recently, the auto cycle likely having passed its peak, and lackluster business investment. Tariff tensions with China and Mexico have amplified the concerns, with trade issues threatening to further sap activity. Calls for recession have grown louder, but, to us, still appear premature. U.S. exports to China represent less than 1% of GDP, and while a final deal with China is still likely a ways off, we expect interim talks to soothe market anxiety periodically, as was the case last week, with a more amicable tone toward negotiations contributing to the rally in stocks. A trade war would be a potential catalyst for economic weakness, but it is not an inevitability, as the U.S. economy is more dependent upon services than goods manufacturing. The strength in last week’s ISM services index offers some comfort that the trade uncertainties (which are curbing factory activity and business investment) haven’t necessarily seeped fully into all facets of the economy.  To that end, it's consumer spending that carries the most weight, and news on that front remains reasonably encouraging. The labor market has been a consistently positive force, as the unemployment rate has fallen from 10% to the current 50-year low of 3.6%. And while we think employment conditions will remain a sturdy tailwind for consumer spending, it's true that the low hanging fruit of job gains has been picked, in our view. Last week’s jobs report was reflective of this, as the U.S. economy added 75,000 jobs in May, well below expectations and a sizable slowdown from the prior month. The wider trend still looks favorable, with monthly job gains averaging 164,000 so far this year and wage growth remaining above 3%2. But at this stage in the cycle, there is less scope for dramatic improvement. While the tepid May jobs report stirs worries of economic fatigue and, in our view, does confirm a deceleration in economic momentum, we don’t think this signals impending doom.  Historically, the unemployment rate has trended notably higher ahead of approaching recessions. Job growth was light last month – perhaps reflecting some hesitation from companies amidst the backdrop of policy uncertainties – but employment conditions remain far more positive than negative.  Trade concerns will not disappear any time soon and will likely tip the market teeter-totter as they continue to capture the lion’s share of the headlines. The ultimate determination of whether the economy continues to grow or falls into recession will largely come from the labor market and household spending, which are likely to remain healthy enough to support moderate GDP growth this year.  Weight advantage: a still-healthy labor market.
  • Hikes vs. Cuts - After a fairly steady campaign of rate hikes from 2015 to 2018, the Fed has done an about face, now favoring a more flexible, data-dependent (dovish) approach to future rate moves. The Fed’s extended period of zero-interest-rate policy during the past decade was the undeniable heavyweight on the teeter-totter, with stimulus supporting the foundation upon which the stock market delivered a more than a 400% return since March 2009.  But tighter policy has countered on several occasions as investors fretted the headwinds of potentially higher rates. Six years ago, stocks dropped 6% amid worries the Fed would taper its bond purchases (i.e., reduce stimulus). A 10% pullback in 2015 came as the prospects of the first rate hike grew closer1. And 2018’s sell-off was driven by concerns that the Fed was overtightening amid looming threats from trade and slowing global growth.  Last week, stocks rallied sharply amid increasing expectations of a Fed rate cut this year. We’ve seen this market response several times throughout this bull market, with stocks rallying on weak or underwhelming data under the premise that it will bring looser Fed policy. While monetary stimulus is a powerfully supportive force for stock prices, we'd prefer a “good news is good news” environment. We don’t think we’ve entered a stage where the economy requires additional stimulus to sustain growth, so an immediate Fed response isn’t assured (or necessarily required) at this point. A flexible Fed is a good thing, but with the markets increasingly pricing in one or more rate cuts this year, investors should anticipate increased volatility as incoming data and Fed commentary reshapes those expectations. Rates are not too high to allow the economy to grow, but uncertainty around upcoming Fed moves will likely be a central market driver ahead.  Weight advantage: the potential of misaligned expectations for the timing or magnitude of upcoming rate cuts.
  • Stocks vs. Bonds – We think the market teeter-totter will remain active, as positive trends and persistent risks take turns pushing. Investors aren’t powerless to the ups and downs, however. Consider the following:
    • Bonds aren’t just rates – One of the key features of bond investments is the reliable yield. But with rates so low – the 10-year rate has dropped to a two-year low on expected Fed rate cuts – bonds may seem particularly unappealing to investors. But remember another value of fixed income: portfolio stability. With stock-market volatility likely to persist, if not rise, bonds can provide a ballast to portfolios, reducing the sting of market pullbacks. Last December, bonds gained as the stock market sold off. In fact, during the last six market corrections, stocks declined by an average of 15%, while bonds averaged a 1.8% return during those periods3.
    • Stocks aren’t out of energy - We don’t think this bull market has fully run its course. The seesaw is just more balanced now.  Historically, a recession and declining corporate earnings are the diet that starves the stock market – conditions that we don’t think will emerge this year. Recent market fluctuations offer an opportunity to enhance diversification. Consider appropriate global stock-market allocations, as well as diversification across asset classes, such as small- and mid-cap stocks, which could benefit from a simmering of trade fears or some renewed economic optimism.
    • Weight advantage: stocks.  We believe stock-market gains will be more moderate as we progress, relative to the 14% average annual return over the past 10 years, but we still think stocks can outperform bonds as we advance in this stage of the market cycle4.

Sources: 1. Bloomberg, S&P 500 price returns, 2. Bloomberg, 3. Morningstar Direct, stock returns measured by the S&P 500, bonds returns measured by the Bloomberg Barclays U.S. aggregate bond index. 4. Bloomberg, S&P 500 annualized total return (including dividends).


Craig Fehr, CFA
Investment Strategist

Index Close Week YTD
Dow Jones Industrial Average 25,984 4.7% 11.4%
S&P 500 Index 2,873 4.4% 14.6%
NASDAQ 7,742

3.9%

16.7%

MSCI EAFE 1,876 3.2% 9.1%
10-yr Treasury Yield 2.08% -0.04% -0.60%
Oil ($/bbl) $54.07 1.1% 19.1%

Bonds

$110.53 0.4% 5.1%

Source: Bloomberg, 06/07/19. Bonds represented by the iShares Core U.S. Aggregate Bond ETF. Past performance does not guarantee future results.


The Week Ahead

Important economic news includes inflation released on Wednesday, with May retail sales and consumer sentiment reported 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.

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