Published June 28, 2019
While we seek cooler places to escape the hot Texas summer, we read Schwab’s latest examination of markets and economies printed below. In the coming couple of weeks, we will reach into our archives and reprint a couple of articles discussing our overall investment approach and why we recommend using TimingCube, FP Research, and other systems that proactively protect our wealth. Herewith is Schwab’s take on the markets:
“Life is 10% what happens to you and 90% how you react to it.”
― Charles R. Swindoll
Running to nowhere?
The last 18 months have been anything but boring, but if you had ignored the market over that time and only recently started paying attention, you may think that little has happened. The running in place analogy is probably better replaced by hiking a mountain. Lots of work involved, many ups and downs, but ultimately—you end up right back at your car where you started.
Lots of movement but little headway
Trade and Fed policy continue to be critical to the outlook for stocks. A comprehensive trade deal is unlikely in the near-term, notwithstanding the planned meeting between Presidents Trump and Xi at the upcoming G20 meeting. The hope is that the meeting leads to the resumption of serious negotiations between the two sides. In addition, we’ve seen that new trade uncertainties can flare up at a moment’s notice; including with Mexico, Canada India, and the Eurozone. To date, the effects have been relatively muted, although the upcoming earnings season will likely tell a more complete story. Corporate confidence is mixed—larger company weaker, smaller company stronger—but consumer confidence remains strong, keeping consumer spending humming.
Corporate confidence is mixed
Although the consumer seems little impacted by trade
If the trade stalemate lingers and/or the next round of tariffs on Chinese imports kicks in, the damage to the economy is likely to escalate. The Fed addressed its concerns about trade and its impact on both the global and U.S. economies; but the burning question remains about the sufficiency of monetary policy ammunition as an offset to weak growth. The month-long inversion of the yield curve has been adding to that angst.
U.S. stocks are hovering around all-time highs, kept afloat by hopes that the Fed will begin cutting rates as soon as the July Federal Open Market Committee (FOMC) meeting. But are rate cuts sufficient to help what is ailing the economy? Absent a comprehensive trade deal, it’s difficult to imagine that executives will be confident enough to expand capital spending, which had been one of the primary rationales for 2018’s corporate tax cut. In addition, Wall Street’s analysts have yet to reflect the recent escalation in the trade war in their estimates for corporate earnings. Given that consensus estimates are already near-zero for the next two quarters (Refinitiv), an additional haircut to those expectations could mean an earnings recession.
What might a U.S. military strike on Iran mean for markets?
Geopolitical tensions always have the potential to be a wild card in the investing deck, with today’s card being heightened potential for military conflict between the United States and Iran. Although it may pose another threat to an already-vulnerable global economy, markets’ past negative responses to U.S. military strikes have tended to be short in duration.
Over the past 12 months, Iranian oil exports have fallen by 90% due to the re-imposition of U.S. sanctions; much of that coming in the past two months. In early May, the United States declined to extend embargo waivers to Iran’s remaining oil customers. We noted at that time that this heavy blow to the Iranian economy, coupled with increasing frustration with the status of the nuclear agreement, may lead to actions by Iranian-backed forces; heightening the potential for military conflict. Since then, Iran appears to have been responsible for two attacks targeting oil tankers near the world’s most critical oil shipping chokepoint, the Strait of Hormuz; as well as the shooting down of a U.S. drone. The United States announced earlier this week that it would send 1,000 additional troops and other military resources to the Middle East.
Iran’s oil exports fall 90%
Within the next month, Iran will likely exceed the caps on uranium enrichment set out in the 2015 nuclear agreement and may restart parts of its nuclear program (The Wall Street Journal). These actions could prompt a military strike by the United States. Limited U.S. strikes on Iran’s naval assets could hinder Iran’s ability to disrupt traffic through the Strait of Hormuz. The U.S. Navy has moved a carrier strike group to the area.
As worrisome as these developments are to a vulnerable global economy—not to mention the human toll that may result—the market impact may be modest. Global stock markets’ past response to U.S. military strikes has been negative, but short in duration. There is a long history of U.S. missile strikes outside of declared war in the past 30 years which we can use to assess the potential market impact of these types of geopolitical events.
Markets and U.S. missile strikes*
The global stock market reaction was mixed—roughly half of the days after the event seeing losses but the other half flat or showing gains—not a pattern we can take much stock in. Larger losses of around 5% took place when the strikes occurred during the Asian financial crisis in 1998 and the global financial crisis in 2008. Oil prices and the U.S. stock market volatility index tended to rise; while gold futures, the U.S. dollar and bond yields were little changed.
Hopefully, a military escalation will be avoided. But, should one occur, the market reaction may be short and brief.
U.S. stocks have made little headway over the past 18 months; and with indexes around the highs of the recent range, another pullback is possible. Continued trade uncertainty and the potential for a limited Fed response could weigh on stocks in the near term; while an easing of trade tensions could keep the rally alive.
Stocks ran mostly in place this week, consolidating June’s rebound and awaiting word from an expected weekend meeting between the Chinese and U.S. leadership at the G20 summit. Monday exhibited this wait-and-see attitude with a -0.2% move while money flowed into Treasury bonds to push the 10-year yield down to 2%. Note: the yield was 3% as recently as December; so this has been a major move in interest rates over the past several months. Tuesday saw stocks lose -1% as a couple of Federal Reserve members expressed caution about a July cut in rates while new home sales showed a notable decline. Stocks posted another flat session Wednesday with strong earnings from semiconductor firm Micron (MU) providing support for the Nasdaq. Slight optimism in Thursday trade with stocks pushing upward by +0.4%. Friday delivered good news for banks as they cleared Federal Reserve stress tests. On the other side, the Chicago Purchasing Manager’s Index (PMI) showed contracting economic conditions in the midwest. The mixed news fed into the market’s overall caution ahead of the weekend’s meeting between President Trump and Chinese leader Xi Jinping. The market is expecting/hoping for at least a resumption of trade talks coming out of this meeting. A surge at the end of the day, perhaps due to the annual rebalancing of index holdings, pushed the S&P to a +0.6% finish.
Stocks held last week’s gains for the most part in a largely consolidating week. The S&P 500 (SPY) dipped -0.34% while the Nasdaq 100 (QQQ) slipped -0.75%. Recently lagging small-cap stocks (IWM) found buyers to add +1.01%.
Warm wishes and until next week.