Equity markets rose 4%, recovering about half of May’s losses as we entered wait-and-see period. The core question for financial markets remains whether trade-inflicted damage on business confidence will take hold faster and/or outweigh the benefit of lower interest rates and ongoing global consumer strength.
The latter two elements had supportive data points over the past two weeks – multiple Fed governors provided dovish commentary on rates, while strong retail sales for May were reported in not only the US, but also in China and Japan. However, more impactful data points will arrive in the coming weeks: the Fed rate decisions on Jun 19 (likely no cut) and Jul 22 (likely cut), as well as a possible G20 meeting between Presidents Trump and Xi at the end of June.
Perhaps most importantly though – at least from my perspective – is that Q2 reporting will begin in four weeks. Economic data suggests that the quarter will show a contraction in earnings, and yet despite that the real highlight will be earnings guidance for the balance of 2019. Street estimates continue to price in a meaningful recovery, anticipating 15%+ earnings growth in Q3 and Q4. Qualitatively, it seems like a stretch that the average management teams will feel comfortable providing such robust guidance in what remains a highly uncertain environment. Combined with relatively illiquid summertime trading conditions, this has reasonable odds of triggering an equity market sell-off.
For greater clarity though, a market sell-off in the range 15% - 25% peak-to-trough would be consistent with a garden-variety recession and would provide a welcome buying opportunity. The list of secular positives remains powerful: historically low unemployment, better capitalization at banks than at any point since WWII, low real interest rates, and continued compounding of technological progress (particularly with 5G becoming mainstream in 2020). In the meantime though, the near-term environment for equity markets contains meaningful downside risk.