Despite a moderate pickup in the Financial Markets subindex, our PWA [Macro] Index declined 2.38 points to 42.36 (this year's lowest score) this week -- as the Economic subindex gave up a notable 6 points, with commercial and industrial loans seeing a large decline and rail traffic threatening to roll over.
While macro conditions have deteriorated notably from where they began the year (81.33 on Jan 15), they still score at a level that supports a continued economic expansion and corporate profits going forward (below zero is the danger zone).
As for the sector charts; while the setup, in the aggregate, remains relatively bullish for U.S. cyclicals, technical conditions aren't what they were coming into the year either.
Coming into the year conditions strongly favored higher long-bond rates, a U.S. economy leading developed foreign economies (supporting my stronger dollar thesis at the time), and gains in financials (higher rates, tax cuts, deregulation), materials and industrials -- over the tech sector.
As things have turned out thus far, tech has been a huge gainer on the year (+17.2%), while financials are essentially flat (+1.2%), industrials are up moderately (+4.5%) and materials are down 1.9%. This defiance of general conditions speaks to the unprecedentedly aggressive posture on trade coming from the U.S. Administration.
Prior to the U.S.’s explicit move toward protectionism, financials and tech were in a dead heat (both up 8.1%) with Industrials and materials gaining 6.6% and 5.9% respectively from the beginning of the year to the 1/26 peak. Since then, again, tech has continued its impressive march higher, while, as stated above, our three top picks have not: This speaks to the fact that the U.S. and China have thus far largely excluded the tech sector from their tit-for-tat game of tariffs. The next round, if Washington makes good on its threats, will draw tech into the battle and I suspect things will get ugly for the sector. The deterioration we saw in tech week before last (-2.7%, while financials, industrials and materials delivered 0.0%, +0.6% and -0.5% respectively) was clearly in anticipation of the escalation promised (but not yet delivered) by the White House.
As for non-US equities, they as well have reacted negatively (more so) to the current trade environment. From the beginning of the year to the 1/26 market peak, developed foreign aggregate, the Eurozone, Asia Pac and Emerging Markets were up 7.0%, 8.6%, 5.9% and 11.0% respectively, while the U.S. S&P 500 was up 7.5%. Since then foreign markets have turned notably negative across the board. Last week, however, upon no announcement of new tariffs, and on news Wednesday that the U.S. has asked China to reengage on trade talks, non-US equities rallied strongly. For the week, developed aggregate, the Eurozone and Asia Pac were up 2.0%, 2.3% and also 2.3% respectively, while the S&P 500 rose only 1.2%. While that’s a very short-term snapshot, last week bolstered our view that non-US equities (as well as U.S. financials, industrials and materials) are poised for a stretch of outperformance (catch up) if/when the trade war comes to a close – as long as general conditions hold up until then. Emerging markets, while higher by a respectable 0.7%, didn’t see as strong a rebound as did other non-US markets last week.
Last week unfortunately finished on a sour note, as it was reported that the President instructed his team to move forward with tariffs on $200 billion worth of Chinese imports, despite the pending restart of negotiations.
In a nutshell, general conditions dictate that we stay the course (an overall cyclical bent to our allocation) for now, while diligently monitoring the macro environment. At some point the cycle will run its course and we’ll be shifting to a defensive posture within client portfolios. The character of that shift will depend on the nature of the slowdown and where interest rates stand at the time.
Should international trade relationships normalize soon, we see very low near-term recession risk, and we think our current sector and regional allocation mix will perform quite well. Should, on the other hand, the trade war not come to a near-term close, or, worse yet, worsen further, we believe general conditions will begin to deteriorate at an accelerated pace, having us adjust sooner than we otherwise would have. In that event, our move to TD Ameritrade’s far nimbler platform couldn’t have been better timed!
In the meantime, the looming mid-term elections stand to be another potential source of equity market volatility…