Welcome Oversold Bounce

June 2019

May was a month worth forgetting for equity investors - the S&P 500 fell 6.5%, the small-cap Russell 2000 plummeted 7.9%, the MSCI EAFE declined just 5.4%, and the MSCI Emerging Markets Index dropped 7.5%. It’s notable that even after a rough month, all four indices remained in positive territory year-to-date by between 4.1% (MSCI EM) and 10.7% (S&P 500) on a total return basis. Things appeared rosy entering May with optimism building on the U.S./China trade front, the S&P 500 hitting an all-time high on May 1, and the CBOE Volatility Index (VIX), a measure of investor fear, entering the month close to a year-to-date low exhibiting investor comfortability. We highlighted bullish positioning and a surge in sales of put options and other structures that would pay off should stocks crater and volatility pick up as at the top of our list of concerns as we entered May. The breakdown in U.S./China trade negotiations the weekend of May 3-4 ushered in a long awaited pullback in global stocks, and a month-long rally in long-dated U.S. Treasury bonds. It took four straight down weeks for the S&P 500, but entering June, investors appeared to be entrenched in stage 4 of the Kübler-Ross “Five Stages of Grief” – depression. Stage 5, acceptance, and a market bottom appeared to take shape as we entered June, but much remains undecided as it relates to trade and FOMC policy, two huge variables overhanging markets.

Over the final two weeks of May, investors quickened the pace of their exodus from stocks and bought bonds hand over fist in as a hedge against a pronounced global economic slowdown stemming from a protracted U.S./China trade standoff, and the out-of-left-field prospect of hiking tariffs on Mexico. To be sure, little on the trade front has been good for the global economic backdrop, stocks, or C-suite confidence, and markets loathe uncertainty. We can’t shake the feeling that much of the recent trade-related news flow may turn out to be posturing in an effort to bring interested parties back to the table for negotiations and to highlight the seriousness of some of these issues in the eyes of the Trump administration. On the heels of 5% tariffs being threatened on imports from Mexico, we can’t overstate how unpredictable U.S. trade policy has become of late – hardly a pick-me-up for equity markets. In addition, we don’t expect near-term resolution on U.S./China trade, but over time equity investors may become more accepting of a stalemate. Maintaining the status quo would be preferable to a tit-for-tat tariff escalation, and is a scenario where more “knowns” may provide at least some level of comfort.

Liquidity remains plentiful, driven by accommodative monetary policy from global central banks. Financial conditions did tighten toward the end of May, which would be a bigger concern for smaller capitalization, more heavily indebted companies if it persists. However, the Federal Open Market Committee (FOMC) is now expected to cut rates multiple times prior to year-end based on Fed funds futures expectations, which would likely ease financial conditions, potentially weaken the U.S. dollar, and alleviate funding concerns by allowing non-earners and issuers in emerging markets to issue debt at lower rates. Emerging markets have been battered on economic slowdown fears tied to trade-related uncertainty, but energy prices stabilizing and a weakening U.S. dollar should provide support.

Investors were net sellers of equity ETFs to the tune of around $20B in May, a level similar to December 2018, and prior to that January 2016. Both months proved to be selling crescendos and a fear peak. Given the daily onslaught of news on trade, geopolitical instability, and political dysfunction globally, pessimism and fear guiding outlooks is understandable, but we always caution against making emotional or rash decisions as the pendulum often swings back, sometimes quicker than you think it could, favoring those able to stay the course. Equities were oversold entering June, setting up a nice bounce to start the month, but significant further gains from here are likely dependent upon the removal of trade-related uncertainty, or an FOMC rate cut materializing near-term. Summertime tends to be boring for investors, with markets moving little in either direction, but there will be a number of potentially market-moving events in June well worth keeping an eye on. Our focus will be on the FOMC meeting taking place June 18-19 and a potential meeting that could occur between President Trump and Xi Jinping at the G-20 meeting on June 28-29. The outcomes of these two events alone could go a long way in determining whether we move higher or lower into the summer months.

Source: Bloomberg, Factset