Dog Days are Over

Sep 02, 2019 | Dann Cushing


Financial markets finished off the dog days of summer in a fitting fashion for 2019: rapid-fire political jabs...

...between the US and China led to another sudden increase in tariffs…and yet after a period of initial volatility, equity markets still managed to gain 1% - 2%. 
In the prior update we reviewed the reality that aside from “fear of fear itself”, it is difficult to make a compelling case for a near-term global recession. At the same time, with uncertainty levels high and with equity markets being partly based on perception, an equity market correction could still quite reasonably occur – particularly through the traditionally treacherous September / October investing period. 
The coming 8-weeks contain a number of meaningful events. The most important of these should prove to be the Fed’s rate decision and commentary on Sep 18. Money markets continue to price in two more rate cuts before January – which on the one hand would be a very significant stimulus outside of a recession, but on the other hand sets the stage for disappointment if the Fed does not comply. It also risks liberating the President to immediately follow it up with more tariffs, as was done in August. 
Other major events over the period will be the new iPhone launch – which typically sets the tone for the tech supply chain (including OLED) – and in October, the start of Q3 earnings. This quarter will include a full month of tariffs for many consumer-focused companies, as well as guidance that will incorporate the further tariffs coming on Dec 15. Street estimates currently predict S&P500 earnings to decline by 3.5% in Q3 even before considering the Sep 1 tariffs; if correct, that will mark the second quarterly earnings decline in a row, technically an “earnings recession”.
Given this backdrop along with the S&P 500 trading at an above-average forward P/E, we continue to handicap the odds for equity investors as “not great” even though the odds for economic growth are “not bad”. Consistent with that, we still see the appeal of tactically taking profits on equities even if it means accepting the opportunity cost from temporarily holding cash. On the upside, the overall market uncertainty does appear to be causing prices for individual equities to draw-down more sharply than normal on negative news, which may create improving opportunities to redeploy cash even absent a general market correction.