July was a mostly positive month for investors. For the equity investor all the US-focused indexes we follow were up more that 1% each. The bond investor saw its index, the Aggregate Bond Index, move higher as well. The dollar reversed its June losses with a strong month. The two losers were commodities and global equities.
U.S. & International Stock Index Returns
|Index July 2019 Year-to-Date|
|Dow Industrials 1.13% 15.16%|
|S&P 500 1.54% 18.89%|
|S&P 400 (Midcap) 1.27% 18.26%|
|S&P 600 (Small Cap) 1.20% 14.02%|
|MSCI World 0.49% 16.12%|
|MSCI EAFE (1.46%) 10.31%|
|Bloomberg Agg. Bond 6.35%|
|CRB Commodity Index 5.14%|
|US Dollar Index 2.84%|
All data as of 07/31/2019, Source: Wells Fargo 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.]
US stock indexes continue to outperform expectations, as well as seasonal tendencies, with all four indexes positive for the month of July. Both the S&P 500 and Dow Industrials were not just positive, but recorded new all-time highs. Global equities, on the other hand, were down on concerns related to trade and global growth. While things are good – very good – for domestic equities, we must take note that we see the recent gains as more of a reflection on the belief that interest rate cuts will be a positive factor than a belief that corporate earnings growth can carry stocks higher.
The strength in bond prices, and drop in yields, continued on this month as the Bloomberg Barclay’s Aggregate Bond Index moved higher again this month. The short-term interest rate cut the market had been pricing in for the July 31th meeting of the Board of Governors of the Federal Reserve came in at 0.25%, not the 0.50% that many market observers had hoped for. The real concern for the market came with Chairman Powell’s comment that the cut should not be viewed as the start of a rate cut cycle, but instead as a “mid-cycle correction.”
The dollar index strengthened during the month of July, moving from the bottom end of its trading range to the top of its trading range, reversing what occurred in June. As we said last month – and most every month since the beginning of the trade dispute/tariff war with China in April, 2018 – we see this move as a reflection on the market’s perception of a resolution to the dispute. If trade talks do not produce a positive move forward, we would expect the dollar to continue to gain strength.
The price of commodities, as measured by the Reuters/Jefferies CRB Index, lost 1.48% in the month of July. That the loss in value coincides with the strength of the US Dollar is no coincidence. Strength in the dollar generally depresses the price of basic commodities. We say generally as individual commodities will act different from the basket due to specific supply/demand issues surrounding said commodity.
Gold is currently a good example of this phenomena. After a long period of trading within a price range the yellow metal’s price surged above the range in June. Because it is viewed as a store of value, in our June R report we suspected something bigger was happening. The unusual situation where both gold and the stock market move higher was not likely to continue for a new normal. The strength in gold has become more unusual in July as the dollar strengthened.
When it comes to the stock market, for most of 2019, Magellan Financial has been constructive on the stock market. We easily admit our bullishness comes with a healthy dose of skepticism about the sustainability of the 10-year equity bull market and longest official economic expansion in US history. Admittedly skepticism is in our DNA. Yet, if there were anytime to look at markets with a cynic’s eye, this far into a bull market would be the time.
What we see happening right now is a divergence from normal market correlations. Stocks and bonds have both been very strong in 2019, which is not the usual. Bonds and commodities are weakening at the same time, suggesting global economic weakness and continued low inflation. Stocks and gold are usually negatively correlated, yet both are strong. And speaking of gold, which as noted earlier has positively broken out of a multi-year price consolidation, it continued its surge higher even as the dollar gained strength. None of this is normal. None of this makes much sense to us.
Which brings us to the beginning of August, one of the historically poor months for stocks. According to the Stock Traders Almanac 2019 (pg. 72) the average August for both the S&P 500 and Dow Industrial Average (DOW) is negative. Of course, this doesn’t mean that the market will print a negative return for the month. It does, however, make us more conscious of factors that could throw the markets for a loop.
From a technical perspective, we have the inter-market divergences mentioned earlier. While the stock market is calling for good times ahead, the bond market (usually the more level-headed of the two) is implying the need for caution. Gold’s move higher also supports caution. Looking at the S&P 500 (Chart #1) we take note of a divergence between the weakness in relative strength (RSI) and momentum (MACD) indicators and the strength in the index as it reached new all-time highs.
From a more fundamental perspective we know that the economy is slowing down. Not only did second quarter growth come in at a pedestrian 2.1%, but 2018 GDP was adjusted down to 2.5% (2.9% initial). Business spending contracted for the second quarter in a row. None of this is close to the 4% growth rate Trump economic advisor Larry Kudlow promoted at last year’s Delivering Alpha conference (source).
And about those interest rate cuts? That doesn’t happen when we are in boom times.
Finally, and possibly most importantly, we have the trade war with China. We have said from the beginning of this that we do not see a realistic end to this impasse given the strong personalities involved on both sides and Trump’s tendency to ask for add-ons to a negotiated deal. Unsurprisingly, terms of a deal do not look to be coming any time soon. From what has been reported we know China is balking at moving forward on the terms the Trump administration deem necessary. As a tool to get concessions President Trump has issued a threat to add more tariffs to Chinese imported goods.
Everything we just stated leads us to one descriptive word for where we stand today: uncertainty.
Everything we just stated makes calling for higher equity prices in the near-term a hard call to make.
As we sit here at the start of August our inner skeptic leads us to taking a very cautionary stance on the equity markets. We are not calling for an extreme selloff, but do see a healthy dose of volatility for stocks in the near term. We will be watching to see what happens with the various markets we follow as well as the geopolitical background.
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All investing involves risks including the possible loss of principal invested. Past performance is not a guarantee of future results.
Index returns are not fund returns. An index is unmanaged and not available for investment.
Dow Jones Industrial Average: The Dow Jones Industrial Average is a price-weighted index of 30 “blue-chip” industrial U.S. stocks.
S&P 500 Index: The S&P 500 Index consists of 500 stocks chosen for market size, liquidity, and industry group representation. It is a market value weighted index with each stock’s weight in the Index proportionate to its market value.
S&P Midcap 400 Index: The S&P Midcap 400 Index is a capitalization-weighted index measuring the performance of the mid-range sector of the U.S. stock market, and represents approximately 7% of the total market value of U.S. equities. Companies in the Index fall between the S&P 500 Index and the S&P SmallCap 600 Index in size: between $1-4 billion.
S&P Small-Cap 600 Index: The S&P SmallCap 600 Index consists of 600 domestic stocks chosen for market size, liquidity (bid-asked spread, ownership, share turnover and number of no trade days) and industry group representation. It is a market value-weighted index (stock price times the number of shares outstanding), with each stock’s weight in the index proportionate to its market value.
MSCI World Index: The MSCI World Index is a free float-adjusted market capitalization index that is designed to measure global developed market equity performance.
MSCI EAFE® Index: The MSCI EAFE Index is designed to represent the performance of large and mid-cap securities across 21 developed markets, including countries in Europe, Australasia and the Far East, excluding the U.S. and Canada.
Bloomberg Barclays U.S. Aggregate Bond Index: Bloomberg Barclays U.S. Aggregate Bond Index is a broad-based measure of the investment grade, US dollar-denominated, fixed-rate taxable bond market.
NASDAQ Composite Index: The NASDAQ Composite Index measures the market value of all domestic and foreign common stocks, representing a wide array of more than 5,000 companies, listed on the NASDAQ Stock Market.
Russell 2000® Index: The Russell 2000® Index measures the performance of the 2,000 smallest companies in the Russell 3000® Index, which represents
Technical analysis is only one form of analysis. Investors should also consider the merits of Fundamental and Quantitative analysis when making investment decision. Technical analysis is based on the study of historical price movements and past trend patterns. There is no assurance that these movements or trends can or will be duplicated in the future.
Stocks offer long-term growth potential, but may fluctuate more and provide less current income than other investments. An investment in the stock market should be made with an understanding of the risks associated with common stocks, including market fluctuations.
Investing in foreign securities presents certain risks not associated with domestic investments, such as currency fluctuation, political and economic instability, and different accounting standards. This may result in greater share price volatility.
Investments in fixed-income securities are subject to market, interest rate, credit and other risks. Bond prices fluctuate inversely to changes in interest rates. Therefore, a general rise in interest rates can result in the decline of the bond’s price. Credit risk is the risk that the issuer will default on payments of interest and/or principal. The risk is heightened in lower rate bonds. If sold prior to maturity, fixed income securities are subject to market risk. All fixed income investments may be worth less than their original cost upon redemption or maturity.
Investing in commodities is not suitable for all investors. The commodities markets are considered speculative, carry substantial risks, and have experienced periods of extreme volatility. Investments in commodities may be affected by changes in overall market movements, commodity index volatility, changes in interest rates or factors affecting a particular industry or commodity. Exposure to the commodities markets may subject an investment to greater share price volatility than an investment in traditional equity or debt securities. The prices of various commodities may fluctuate based on numerous factors including changes in supply and demand relationships, weather and acts of nature, agricultural conditions, international trade conditions, fiscal monetary and exchange control programs, domestic and foreign political and economic events and policies, and changes in interest rates or sectors affecting a particular industry or commodity. Products that invest in commodities may employ more complex strategies which may expose investors to additional risks, including futures roll yield risk.
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Robert I Cahill, Managing Partner Rob.Cahill@wfafinet.com
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