A Week of Headline Turmoil ending on a Strong Note
Written by: Martin Shields
It’s a constant refrain that our clients hear and we may sound like a broken record but we continually stress the importance of not looking at the headlines and wondering how they will impact their portfolios. It is the scary headlines that will sell advertising for the media and that will move the stock market dramatically in the short-term but it’s the trending economic data and corporate profits that determines the market’s long-term direction. This week is a perfect example of why we constantly espouse this recommendation. The S&P 500 index dropped by 1.5% on Monday because of the headlines and by this afternoon it was up almost 0.30% for the week and more than 1.5% for the year while the Nasdaq index was down by 1.0% on Monday and up 1.84% for the week and more than 9.0% for the year.
The headline turmoil started over the weekend when Italy’s President Mattarella vetoed the nominated euroskeptic Economic Minister, Paolo Savona, based on concerns that Mr. Savona could try to remove Italy from the Euro. This move opened the possibility of early elections in Italy which could allow the anti-Europe and anti-euro parties to take control. Because of the fresh memories of Brexit two years ago and the fact that Italy is Europe’s third largest economy, the bond and stock markets in Europe and to a lesser extent in the U.S. went into a panic mode not seen in many years. This is a perfect example of how the market overreacts to headlines before fully understanding the true risks of the headlines. The next day, a large Italian bond auction went off without an issue and by yesterday, an agreement was established with the coalition government to select a prime minister and other ministers who have more moderate views. This doesn’t mean that Italy or Europe have resolved their currency, economic and political issues. Italy still has one of the largest debt loads of any developed country and the economy is smaller than it was in 2008. Also, Spain has upcoming elections that could prove to be problematic.
The other headline that continues to cause market volatility is the concerns over a trade war. This came to the forefront yesterday when President Trump imposed tariffs on the EU, Canada and Mexico steel and aluminum and they responded with similar tariffs on U.S. goods. These headlines came after the U.S. announced on Tuesday that it was moving forward with imposing $50 billion in tariffs on imported Chinese goods and not surprisingly, China responded that they would be willing to respond with similar tariffs on U.S. goods. Although, we firmly believe that if these tariff proclamations continue to escalate and are actually implemented, they would negatively impact the U.S. economy and could potentially ramp up inflation, we feel that these statements are part of the administrations negotiating tactics and the tariffs are unlikely to go into effect or exist for any extended period of time.
Finally, the May jobs report was released today and it shows continued strength in the economy with 223,000 new jobs added and the unemployment rate dropped 0.1% to 3.8%, the lowest rate since April 2000. Wages increased for the month but at a reasonable rate of 0.3%. This data will support the Federal Reserve raising rates this month and at least one if not two more times for the remainder of the year. It was also reported this week that consumer spending increased by 0.6% in April, the largest increase in five months.
Our outlook is positive for the U.S. economy and we expect interest rates to slowly march higher. With this outlook, we continue to be overweight equities versus bonds. Although we think International equities can do well this year, we also continue to be underweight international equities versus our benchmark because of some of the long-term uncertainty in Europe.