Summertime and the Market’s Ups and Downs

By Ketu Desai

What a difference a month makes. A month ago, the economic data was encouraging, and it was widely expected that the trade negotiations with China were concluding. Now there are serious questions on the outlook for both. Trade particularly took a turn for the worse during the month. The market hung on every tweet and headline, causing a 6.6 percent drawdown during the month. The market is now playing the waiting game until the G20 at the end of June when the leaders of their respective countries are expected to meet. Goldman Sachs estimates that continued escalation of the trade war would hit US GDP by 0.5 percent and Chinese GDP by 0.8 percent. The hit to confidence and sentiment could be far greater. The earnings impact to many companies will also be far more severe. For instance, a Goldman Sachs research note came out that said Apple's earnings could drop 29 percent if China were to ban its products.

A similar impact would be felt across a number of other companies across retail, semiconductors, industrials, and materials. After a strong start to the year, the selling could have been a lot worse, however, many investors are reluctant to sell because a tweet or headline could spark a rally, just as a Sunday afternoon tweet started this sell-off. Further, if things continue to deteriorate, investors will look to the “Fed put", the Fed fund futures market is already expecting a rate cut. On the last day of the month, the President of the NY Fed said that, short-term rates should be “cut aggressively" when a severe downturn threatens.

The recent economic data has been underwhelming. After a strong 3.1 percent GDP growth rate in the first quarter, the second quarter is only tracking 1.2 percent according to the Atlanta Fed. The data has been weak across a wide spectrum of the economy, retail sales declined in April, US manufacturing PMI is barely in expansion territory and at the lowest levels since 2009, durable goods were down over 2 percent in the latest release. The numbers have also been weak across the globe. Both Japanese and European manufacturing PMIs have fallen into contraction territory. Chinese retail sales, industrial output, fixed asset investment, and PMIs all disappointed in the latest readings. That said, many of these data series are highly volatile, and it was widely expected that global growth would slow down this year to around 3 percent, with the US slowing to a low to mid 2 percent range, however, the markets remain on edge due to the length of the recovery, the trade war, the recent macro data, and how much fixed income yields have fallen.

A general tone of risk aversion drove the action during the month. The 10-year yield breached 2.15 percent during the month, late last year the 10-year was more than a full percentage higher. Parts of the yield curve inverted again during the month, but not the important 2s/10s. The bond market is clearly pricing in lower expected growth and inflation. As yields have fallen, equity markets have bid up yield and defensive stocks, particularly REITs and utilities. Utilities now trade at 19.1x, versus their historical average of 14x, and the S&P at 17x. As investors bought utilities, they sold tech. Tech is at the center of the trade war, and impacted names were aggressively sold. Semiconductors in particular were crushed with names such as Xilinx, Intel, Nvidia, Micron, Qualcomm, Broadcom, Texas Instruments, all down double digits, and many of these down more than 20 percent. The trade war combined with some poor earnings reports took its toll on retail stocks as well. Names such as Gap, Abercrombie & Fitch, J. Jill, Canada Goose, PVH, Capri Holdings, and Lowe's all had brutal months. Simply, the market is looking for clarity on the economic outlook and trade, and until it does, it will likely be volatile.

Looking forward, the market will be focused on the G20, trade war headlines and tweets, the Fed, and economic data.


Ketu Desai is the Principal of i-squared Wealth Management Inc. ( ), an investment management firm based in New Jersey.