Stocks powered through trade war jitters, a slowing global economy, a government shutdown and sluggish corporate earnings to notch their strongest performance in two decades after Federal Reserve suddenly became the market’s knight in shining armor.
Worried that U.S. tariffs on Chinese imports will raise prices on everything from cars to clothing?
Chill out. It was nothing that couldn’t be at least temporarily defused by the Fed’s abrupt reversal of a plan to raise interest rates, followed by a strong signal to cut rates as soon as next month.
But while the prospect of Fed rate cuts can allow stocks to keep treading water in the second half of 2019, it likely will take a settlement of the historic trade standoff to propel the record 10-year-old bull market higher, analysts say.
“I think the second half really comes down to what happens with the trade war,” says Chris Zaccarelli, chief investment officer of Independent Advisor Alliance. “If we get a resolution with China, stocks can go higher. If we don’t…stocks can definitely go lower.”
Has market peaked?
In other words, the Fed seems capable of creating a floor for stocks but it may no longer turn the economy and market into the “rocket ship” that Trump believes would result from lower rates.
It will be tough for the market to beat a standout first six months of 2019. The Standard & Poor’s 500 index surged 17.4% for the first half of the year to close at 2,941.76, the benchmark’s best performance since 1997. . The blue-chip Dow Jones industrial average is up about 14% in the first six months of the year to close at 26,599.96 on Friday. And the tech-heavy Nasdaq, led by stalwarts such as Apple, Amazon and Facebook, is up almost 21% in the period to 8,006.24.
That means a 401(k) plan invested in a broad S&P 500 index fund and worth $100,000 at the end of last year has appreciated to about $117,000.
But let’s put the gains in perspective. The S&P 500 and Dow are both slightly below their early fall peaks, meaning the market effectively has moved sideways since, with lots of stomach-churning swings in between.
Wild ride
Here’s a rundown: Stocks plunged late last year after the Fed raised interest rates for a fourth time in 2018 and signaled two more hikes this year despite a slowing global economy. Equities rallied in the first quarter as Fed officials announced a hiatus from rate hikes. Yet Trump’s move to increase tariffs on $200 billion in Chinese imports to 25% and threats to slap similar duties on the remaining $300 billion in Chinese shipments, as well as on all Mexican imports, sent stocks tumbling in May.
But hold on. The market shot higher in June after the Mexican impasse was resolved with the country agreeing to crack down on Central American migrants and hopes built for Trump’s summit with Chinese President Xi Jinping this past weekend.
In other words, the market has been dominated by two storylines: trade wars and the Fed. That duet will probably remain at center stage in the second half with positive trade developments now needed to take the starring role. A truce that simply suspends the final round of tariffs and sets further talks without resolving broader issues — such as China’s alleged theft of US intellectual property — will likely keep the economy and market muddling along, experts say.
“Until the tariff situation is resolved, we’re going to have a range-bound market,” says J.J. Kinahan, chief market strategist for TD Ameritrade.
Stocks also have to compete with history. Markets that advance more than 15% in the first half of a year average 3.1% gains in the second half, according to Strategas Securities.
Lackluster earnings
And this market’s fundamentals have not impressed. S&P 500 earnings dipped 0.4% in the first quarter from the same period a year ago and are projected to decline 2.6% and 0.3% in the second and third quarters, respectively, according to FactSet, the first drops in three straight quarters since 2016. Blame the weak global economy, trade war worries that have damped business confidence and investment, and a record 10-year-old U.S. economic expansion that may be running out of steam.
“The U.S. economy is in the late stages of its growth,” says Jonathan Heckscher, chief investment officer of Pennsylvania Trust. “Growth will continue to slow even with a China trade deal,” limiting the upside for stocks. Many economists are forecasting a recession in 2020.
What then has been propping up stocks?
“What else do I do with my money?” Kinahan asks, especially with 10- year Treasury bonds yielding a piddling 2%.
Zacarelli thinks the market has more room to run. Solid job and wage growth continue to underpin healthy consumer spending. And a resolution of the trade war that removes business uncertainty could unleash pent-up demand for new equipment and factories, driving stocks 5% to 10% higher by year’s end, Zacarelli says. At the same time, he says, if the negotiations break down, the market could slide 15%.
Stock analysts overall are sanguine, predicting earnings will grow 6.7% in the fourth quarter and in double digits early next year, according to FactSet. Zacarelli says that forecast hinges on a sweeping trade deal with China.
Meanwhile, Heckscher advises clients to minimize risk and shift investments from small companies and those with overseas exposure to large “domestically-focused” firms.
Noting real estate and consumer staple stocks, along with gold, have gained favor lately, Heckscher says, “These are all places to hide more than places to grow.”