Thus far, 2019 has been the year of the pivot. There was the pivot on monetary policy by Fed Chair Powell in early January, and more recently there has been a pivot on trade dealings by President Trump.
The Powell pivot energized the market. The Trump pivot has sucked the energy out of it.
That's because the Powell pivot, which dissolved the Fed's hawkish mindset, gave the market a sight line to improved economic and earnings growth in the back half of the year, whereas the Trump pivot, which dissolved the expectation for a trade deal happening soon with China, has left the market blinded with uncertainty about economic and earnings growth prospects.
Hard Knocks on Easy Street
The stock market appeared to be on easy street the first four months of the year, riding a wave of enthusiasm about the Fed standing pat with its monetary policy, and the U.S. and China making strides toward striking a trade deal that would presumably lower tariffs, clamp down on IP theft and forced technology transfers by China, and bolster global growth prospects.
It was a comforting combination, yet things quickly turned uncomfortable when President Trump tweeted in early May that he had grown frustrated at the speed with which China was negotiating and that the U.S. would be raising the tariff rate on a $200 billion tranche of imported Chinese goods from 10% to 25%, effective May 10. For good measure, he threatened to place a 25% tariff on an additional $325 billion of imported Chinese goods.
Soon enough, it was said that China reneged on its previous commitments in trade talks. China for its part suggested it was the U.S. that undermined matters with bully-like negotiation tactics. Ever since, there has been a lot of finger pointing, plenty of inflammatory remarks on both sides, retaliatory action and threats of more retaliation, and hefty losses in the stock market.
The S&P 500 was down 6.3% in May as of this writing, which isn't bad relative to the 15.9% decline in the Philadelphia Semiconductor Index and the 9.8% decline in the Dow Jones Transportation Average.
The only sector to escape the sell-off has been the real estate sector. It is up 0.7%, versus losses ranging from 1.7% to 11.3% for the other ten sectors.
Conversely, the Treasury market has gone on a tear, benefiting from safe-haven flows and relative value trades stemming from the drop in the 10-yr German bund yield to a record-low -0.21%.
Walk It Back
What the market has done effectively is retrace some of the steps it took to price in better earnings growth potential when it assumed a trade deal with China would be coming soon. Alas, prices are being walked back, earnings growth optimism is being reined in, and P/E multiples are getting compressed.
President Trump added another wrinkle of uncertainty to the mix at the end of May, telling the world that the U.S. is planning to impose a 5% tariff rate on all imports from Mexico, effective June 10, as part of a strategy aimed at getting Mexico to help curb the flow of illegal immigrants into the U.S.
What's more, if the U.S. doesn't think Mexico is doing enough, it will raise the tariff rate in 5% increments on the first day of each month until it reaches 25% on October 1, where it will remain until the U.S. is satisfied Mexico has substantially curbed the flow of illegal immigrants through its territory and into the U.S.
The tariff action on Mexico was a surprising pivot, which simply exacerbated the market's growing concerns about weakening global growth prospects.
The Treasury market has been the epicenter of the growth concerns and a focal point of economic debate given the widening inversion between the 3-month yield (2.35%) and 10-yr note yield (2.13%) -- the most reliable predictor of recession among the different term spreads, according to researchers at the Federal Reserve Bank of San Francisco.
There is a school of thought, however, that suggests that inversion isn't so much a harbinger of a recession in the U.S. as it is the functional outcome of a search for yield among foreign investors staring at negative yields, or negligible yields, in their home markets.
It's a fair argument when taking into account that high-yield spreads haven't blown out in the face of the growth concerns that have stood out in the stock market with the stark underperformance of the cyclical sectors. That blow out could eventually happen. We're simply noting that it hasn't happened yet.
What It All Means
This difficult path on which the stock market now finds itself isn't entirely surprising. We warned in our Market View update on March 21 that the "easy money" had probably already been made and that nothing had happened yet to upset the view that a second-half recovery is going to happen.
Well, that view has been upset.
It has been upset by the pivot on trade; and some participants are upset that the Fed doesn't sound eager to lower the target range for the fed funds rate even though it doesn't have designs on raising the target range anytime soon either.
Basically, they want the Fed to pivot even further than Fed Chair Powell pivoted in early January. That is evident in the fed funds futures market, which is pricing in two rate cuts by the end of January 2020.
A growing number of economists think the tariff impact will force the Fed's hand. We're not so sure the Fed will be as quick to cut rates as the market might like, simply because the market is doing the Fed's work for it already.
In turn, the Fed is probably loathe to make a rate cut that it is perceived (yet again) as catering to the whims of the financial market if the economic data aren't corroborating the negative price action.
May was a bad month for the stock market after four, very good months. It made sense, though, given the pivot on trade and how it upset the rose-colored view of the second-half outlook.
In brief, it introduced a new layer of uncertainty in a thickening stratum of uncertainty that has seen an "easy" trading and investing environment through the first four months of the year pivot to one that is now more difficult.