“It is difficult to see clear, near-term catalysts that can push the market in either direction from here. Central banks are on hold indefinitely, the White House appears pot-committed on a trade deal with China, new earnings data will not be available for 2-3 months…even the Section 232 review decision (due any day) seems unlikely to cause anything but localized fireworks in the auto sector.” 

 

So three-for-four, but the most important one was wrong. Interestingly though, so far the negative change in US-China trade negotiations has only been big in terms of investment strategy. From a market impact perspective, the above thesis of flat-ish equity retuns through Spring/Summer remains on-point for now: the S&P fell 3% over the past two weeks, which is only a 1.3 standard deviation move. Global markets including China fell slightly more, while on the other hand the TSX was down only 0.5% as Iranian tensions lifted energy equities. 

The market response has been muted, but the impact on investment strategy shouldn’t be. Recall that the direct economic impact of US-China tariffs is modest, at something below 0.5% for China’s GDP and far less for US GDP (see attached JPM note with relevant highlights on pages 1 & 4; or reference the Paul Krugman article that I flagged last year). The real fear back in Q4/18 was not tariffs themselves, but rather that despite historically low unemployment and relatively low interest rates, trade uncertainty would trigger a deterioration in business confidence and cause a negative feedback-loop, ending the current economic cycle. 

 

That “fear of fear itself” proved accurate, with global PMI data and especially global capex figures deteriorating meaningfully through Q1. The challenge is that after a supportive U-turn from the Fed and a sudden, positive change in the tone by the White House on trade talks during Q1, economic data has only just begun to shows signs of stabilizing. Now that one of these two supports has been taken away and replaced with uncertainty (which is arguably worse for businesses and markets that just straight-up bad news), the destructive business confidence feedback loop has a not-insignificant risk of resuming. 

 

In summary then, there are no major market catalysts for the foreseeable future while a qualitative factor (business confidence) bounces between the positives of easing monetary policy and the negatives of trade. To use one of Warren Buffett’s analogies, the current set-up does not look anything like a fat pitch down the middle – particularly with equity market valuations slightly above the 5-year average. Over the past few years, we have been uniformly bullish on equity markets with one exception, which was in August 2018. This is the second exception.