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Market Review May 2019

-Darren Leavitt, CFA

Equity markets did an about-face in May with the S&P 500 inking its first monthly loss of 2109.  Investors fled risk assets for safe-haven US treasuries as trade negotiations between the US and China soured.  Trade uncertainties were further exacerbated by a late-month announcement from President Trump that the US would tax Mexican goods.  For the month, the S&P 500 lost -6.58%, the Dow fell -6.69%, the NASDAQ shed -7.93% and the Russell 2000 closed down -7.90%.  International equities also took a hit.  Japan was off -4.87% while German markets lost -6.53% and Chinese large caps fell -9.26%.  Cyclical issues were the hardest hit as evidenced by a nearly 16% loss in the Philadelphia Semiconductor Index and a 10% loss in the Transportation Index.  Real Estate was the only sector that saw a gain for the month.  Global yields fell as equities sold off.  The US 2-year note yield fell 33 basis points to close at 1.94% while the 10-year bond yield lost 37 basis points to close at 2.14%.

The German Bund fell to its lowest level since the financial crisis with a negative yield of -0.21%.  Negative rates in Germany and Japan along with relatively lower rates internationally likely helped push US yields lower as investors sought a relative value in treasuries.  Interestingly, the 3-month US T-bill and 10-year US Bond yield spread inverted to 23 basis points a level also not seen since the financial crisis.  Of note, an inversion in this relationship has been a harbinger of an impending recession.   Additionally, the Fed Funds futures markets have now priced in two rate cuts by the end of January 2020.  Oil was especially hard hit in May as growth concerns coupled with increased supply weighed on the commodity.  WTI lost just over -16% in the month to close at $53.48 a barrel.  The move in oil was also somewhat of a surprise given the increased tensions between the US and Iran- tensions in the Middle East generally put a bid into the commodity.  Despite its safe-haven status, gold was fairly muted and only gained ~$19 or 1% to close at $1305 an oz.

The month of May’s market action centered around increased trade tensions and the subsequent reset of expectations for economic and earnings growth on a more pessimistic outlook for a trade resolution.  Up until May, investors had felt pretty optimistic regarding trade negotiations between the US and China.  There were certainly some issues that remained, but generally, investors remained constructive that a deal could be reached.  However, negotiations came to an impasse in early May as President Trump announced that the US would increase tariffs to 25% from 10% on 200 billion in Chinese goods.  Additionally, he earmarked an additional 325 billion of potential goods that could also be taxed.   He cited a lack of progress in talks as the reason to boost the tariff rate.  As one might expect, the Chinese retaliated with increasing tariffs on some US goods.  Throughout the month the situation deteriorated as the US announced that it would no longer allow US companies to do business with Chinese telecom equipment, Huawei, due to concerns about the security interest of the US and its allies.

The announcement hit the US telecom equipment supply chain hard with semiconductor names taking the brunt of the sell-off.  Again, as one might expect, the Chinese were rumored to have produced their blacklist of US companies and rumored to have put a halt on further purchases of US soybeans.  President Trump and Chinese President Xi are both going to attend the G-20 meeting in late June, and recent reports suggest that it is likely the two leaders will meet, but currently the two sides continue to be far apart on any trade resolution, and it’s more likely that tensions will escalate in the near term.  All that said, more fuel was added to the fire with the late-month announcement that the US would impose an initial 5% tariff on all Mexican goods entering the US starting June 10th.   Additionally, the tariff will increase by 5% each subsequent month until October 1st when the tariff could be at 25%.  The decision to put a tariff on Mexican goods was made to encourage the Mexican government to do more to curb the flow of undocumented immigrants migrating to the US.  The announcement came as a surprise to most and will most likely induce some form of retaliation and perhaps shelve the recent USMCA trade deal that had been reached to replace NAFTA.  The announcement is odd given that the President, had in the prior week, recommended that Congress ratify the USMCA trade deal and then went on to further suggest that if the deal did not get ratified it would have a” significant negative impact on the economy.”  It’s no wonder trade remains the number one source of uncertainty for investors.

Technically, the market also looks vulnerable.  After making new highs in April, the S&P 500 has now fallen below key levels of support, specifically its 50 day moving average of 2870 and more importantly its 200 day moving average of 2775.  Additionally, some technicians have pointed to a chart formation referred to as a head and shoulders pattern which was formed last week as the index was unable to hold above 2805.  The pattern suggests we may have further room to the downside.

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