June results could best be described as mixed. For equities global markets were down, as was the Dow Industrials in contrast with the three S&P indices we follow – 400, 500, 600 – which were all modestly positive for the month. The strength of the US dollar continued as commodity strength waned. The Barclays Aggregate Bond index was slightly weaker in June.
U.S. & International Stock Index Returns
|Index June 2018 Year-to-Date|
|Dow Industrials (0.58%) (1.81%)|
|S&P 500 0.49% 1.67%|
|S&P 400 (Midcap) 0.28% 2.69%|
|S&P 600 (Small Cap) 1.05% 8.66%|
|MSCI World (0.17%) (0.67%)|
|MSCI EAFE (1.34%) (4.49%)|
|Bloomberg Agg. Bond (1.62%)|
|CRB Commodity Index 0.75%|
|US Dollar Index 2.97%|
All data as of 6/30/2018, Source: WFA Investment Institute. [Wells Fargo Investment Institute, Inc. is a registered investment advisor and wholly-owned subsidiary of Wells Fargo Bank, N.A., a bank affiliate of Wells Fargo & Company.]
June was a mixed month for the equity markets with the global indexes all down and the US-based indexes mostly up. The big divergence at homes was the Dow Industrials printing a negative month. Given the thirty Dow stocks are global in nature, and the trade war that appears to be getting started, we are not surprised to see this index lag. We are, however, a wee bit concerned for a number of reasons.
First, and what should be most obvious, is the trade war with our trading partners. Tariffs bring higher prices which leads to less sales which leads to lower profits. Like it or not we live in a global economy where the goods and service we sell and purchase come from all over the globe. Don’t believe it? Take a look at the tag in the clothes you are currently wearing or research where the parts of your car were produced. Those iconic American Levi’s jeans you think are home grown are actually manufactured in Thailand – the exception would be the $178 501s.
And the markets have been reacting to the intensification trade tensions. Overseas most every stock market has been weak. Back home equity markets have been shaky, not making any real progress even as corporate earnings have been at record levels. Small company stocks have been the exception, but in our opinion that has more to do with combination of the stronger dollar and corporate tax cuts.
If you take a look at the three charts located at the bottom of this section the weakness among global companies becomes evident. At both the February and April lows the S&P500 (chart #1), the S&P600 (chart #2), and the Dow Industrials (chart #3) all bottomed out right around their respective long-term support at the 200-day moving averages. In March both the S&P500 and Dow Industrials both peaked before bottoming again in April. In June, neither index broke above their March highs. As we start July the Dow has fallen to just below the long-term support while the other indices have held at the short-term support of the 50-day moving average.
It is impossible to know at this point if we are at an inflection point for more broad-based market weakness or if the divergence is just a temporary condition which will resolve itself quickly. While we whole heartedly believe earnings drive the markets long term, here in the short term are the optics of a trade war along with the real possibility it could start to damage corporate fundamentals.
The 10-year Treasury bond spent the month seemingly off the radar screen with no action of note. Yields eased down after making two weak attempts to get back to the 3.00% level early in June. The slide down in 10-year rates coincided with The Federal Reserve announcement that it raised short-term interest rates. As a result of the rate movement divergence the spread between the 2-year Treasury and the 10-year Treasury tightened to 35bps by month’s end.
With two more expected rate increases by year end there is a real possibility that rates will invert (short term rates will be higher than long term rates). Inversions are rare, but noteworthy as it is viewed as an indicator of an approaching economic recession. Needless to say, such a scenario would have implications for all the markets we follow.
After a very strong move the US Dollar Index has spent the past six weeks in a trading range just below the key resistance level of 95. This could be the end of dollar strength … or just a pause before the move higher continues. Honestly, we do not know how this will resolve itself. What we do know, however, is that how it resolves itself will have implications for other asset classes.
US multinational companies will continue to be pressured if the dollar gets stronger, as will emerging market countries. US small company stocks, on the other hand, generally do well in a rising dollar environment. Commodity prices receive a wind at their back when the dollar weakens as they typically trade in dollars.
The upward trend for commodities took a hard turn lower this month as the CRB Index fell from 202 to below 193 mid-month. Such a correction is not unusual for commodities which can become volatile at times. A positive for the sector was the quick rebound off the lows, which happened to be at the 200-day moving average.
Every month we review what happened in the various areas of the stock market before taking out our crystal ball to take a look into the future and what may or may not happen. When we do this, we are looking at the stock market – indices that are aggregates of various individual stocks that trade on the exchanges. And this makes sense as 75% of stocks will go higher in a bull market while 75% will go lower during a bear market.
As we look through the windshield the view is rather murky. Historically July is a good month for stocks. Over the past 65 years the S&P500 has had an average gain of 1% for the month. While every year is different, we find some comfort in this fact. Yet we also know August and September are historically poor months for the equity markets.
What we do not know is how this whole trade issue resolves itself, if indeed it does get resolved. Politics aside we wonder what the endgame is to the back and forth threats of protectionist tariffs. How it ends will have a strong impact on where the stock market ultimately goes in the intermediate term.
If you are a regular reader you know that we believe markets are interrelated. Over the past few months we have witnessed the US Dollar index rise from the 89 level to a recent high right around 95 – a large move for a currency in such a short period of time. As a result, US-based multinational corporations stock prices have weakened and small domestic companies (S&P600) have generally performed well. Recently, however, as the possibility of protectionist tariffs becomes reality the dollar has stalled out at the 95 level. We do not believe this is a coincidence. Implementation of protectionist policies should weaken the dollar as the world adjusts to a new world order.
Commodity prices, which trade in US dollars, would have a tailwind. Consumers would be looking at potentially higher prices for gasoline at the same time corporations would be dealing with higher input costs. This is not good for either the consumer or the companies we purchase from.
Which leads us back to the stock market. Just as small companies have moved higher with the dollar we would expect them to retreat with dollar weakness. Big companies, one would assume, should get a boost. Under normal circumstances that would be the logical conclusion. But trade wars are not normal times.
We are not trying to be alarmists but realists. Nobody knows what will happen with international trade in the coming weeks and months. The best case or the worst-case scenario are both on the table in our opinion. And that’s the issue – UNCERTAINTY. Markets HATE uncertainty.
What we can tell you for sure is historically July is normally a good month for stocks while August and September are challenging. Throw in a big dose of ambiguity surrounding trade and we get cautious.
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Robert I Cahill, Managing Partner Rob.Cahill@wfafinet.com
Jeffrey T. Bogert, Partner
Jonathan D. Soden, Partner Jon.Soden@wfafinet.com
Robert Sweeney, Financial Advisor Bob.Sweeney@wfafinet.com
Jay Knight, Associate Financial Advisor Jay.Knight@wfafinet.com