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MARKETS DROP FOR FOURTH WEEK IN A ROW AS MEXICO GETS HIT WITH TARIFFS AND RHETORIC WITH CHINA HEATS UP

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Weekly Market Update — June 1, 2019

  • Stalling U.S.-China negotiations and new tariffs on Mexico conspired to push the U.S. markets down this week, causing the markets to register their first monthly decline in 2019
  • The week saw the smaller-cap Russell 2000 lose 3.2%, the concentrated DJIA drop 3.0%, the broad-based S&P 500 shave off 2.6%, and NASDAQ lose 2.4%, which pushed the monthly losses for all the indices to between 6-8%
  • Not one of the 11 S&P 500 sectors finished green this week and most of them had losses more than 2%, with the Energy Sector plummeting 4.5%
  • The S&P MidCap 400 Index joined the small-cap Russell 2000 Index in correction territory, as it is off more than 10% from last summer's high
  • The big unexpected headline was late in the week, when President Trump announced a 5% tariff rate on all goods imported from Mexico starting June 10th. The tariff rate will increase periodically until it hits 25% unless Mexico helps reduce the number of people entering the U.S through its borders
  • WTI crude dropped 8.8% and now stands at $53.48/barrel, a more than $5 decline on the week
  • The 2-yr yield dropped 20 basis points to 1.94% and the 10-yr yield dropped 19 basis points to 2.13%
  • The U.S. Dollar Index advanced 0.2% to 97.76

Weekly Market Performance

Tariffs on Mexico

The markets received a surprise on Friday when President Trump announced the imposition of a 5% tariff on about $350 billion of Mexican goods that starts June 10th and increases every month until it reaches 25%.

The tariffs are tied to helping curb immigration flows from Mexico and will be imposed in about a week, ratcheting up quickly as the summer wears on. Many are suggesting that these tariffs are a heavy-handed negotiation tactic and are designed to get Mexico to respond and few expect the tariffs to actually reach 25%. But we shall see.

Nevertheless, the tariffs will hit a lot of goods – $350 billion worth of goods like automobiles, TVs, and computers, so it is likely that consumer prices could rise in the latter half of 2019. Further, the risk of higher tariffs and additional trade disputes will certainly add more volatility to the markets.

Interest Rates Falling

With May turning in the first negative month of 2019 for equity investors, many may have missed the significant drop in the 10-year Treasury over the same period. As May came to a close, the 10-year Treasury closed at 2.13%, which is the lowest rate in almost two years.

Maybe more importantly, however, is the fact that we’re seeing another inverted yield curve, which can be worrisome as such events often precede recessions. The 10-year is at 2.13% and the 3-month stands at 2.29%, which is a pretty big difference.

While it’s true that at times an inverted yield curve has signaled recessions, half the time stocks have risen the following year. But it's worth keeping an eye on because when an inverted yield curve did precede a recession, the recession was not felt for at least a year to three years afterwards.

Earnings Estimates

FactSet reported that during the first two months of the second quarter, analysts lowered earnings estimates for companies in the S&P 500 for the quarter by 2.1% (to $40.61 from $41.46). How significant is this decline?

Consider this:

  • During the past five years (20 quarters), the average decline in the bottom-up EPS estimate during the first two months of a quarter has been 2.5%.
  • During the past 10 years, (40 quarters), the average decline in the bottom-up EPS estimate during the first two months of a quarter has been 2.2%.
  • During the past 15 years, (60 quarters), the average decline in the bottom-up EPS estimate during the first two months of a quarter has been 3.1%.

In other words, the 2.1% decline in the EPS estimate recorded during the first two months of the second quarter was smaller than the five-year average, the 10-year average, and the 15-year average.

More Glass Half Full

Naysayers are lamenting the fact that May was the worst month for equities so far in 2019 and they’re not wrong. But, consider this: after 5 months, the S&P 500 has still delivered more than 10% to investors when you include dividends (actually 10.7% with dividends included).

Further, bonds have delivered positive returns, with the Bloomberg Barclays US Aggregate Bond Index up almost 5% on the year.

Glass-half full investors would say that the markets are actually returning to their historical trend lines and more balanced markets bode well long-term.

Sources

factset.com; statista.com.com; standardandpoors.com; nyse.com; federalreserve.gov; msci.com; nasdaq.com; dowjones.com; morningstar.com; edwardjones.com; bloomberg.com