There is no denying it: May was a tough month for the market. By the end of May, the S&P 500 Index was down around 6.5% from the high reached at the end of April. Investors are asking if this is a typical, “sell in May and go away” phenomenon or is there something more to the decline? They want to know what is really going on.
Is it the weight of the trade war with China? Is it our yield curve inversion between the three-month Treasury yielding 2.35% and the 10-year Treasury at 2.14% as of May 31? In my opinion, risks are rising in the global economy that may not go away in the near term.
We’ve had a good run since the market bottomed on March 9, 2009. The S&P 500 alone has grown more than 403%, which averages to a total return of 17.11%. This is exceptional performance for an economic cycle, but cycles do end. I have mentioned the yield curve being inverted. Yield curve inversions have preceded the last seven recessions by an average of 15 months. The Federal Reserve has also indicated that there may be no rate increases to the Fed Funds rate in 2019. All of this can lead investors to believe there is a recession ahead. I believe these should be signs of caution, not the backdrop for panic.
Investors’ eyes are also turned to China. Tariff talk started around in late 2017 and largely went into effect in early 2018. Since then, it has been a back and forth escalation between the United States and China.
For a long time, I believed that the tariffs and threat of a trade war were a negotiation of President Trump. In 2018, every time there were comments from the president that talks were in session and a deal was in the works, the market responded. Now, the sensationalism is wearing off, and reality is setting in. President Trump still has room to increase tariffs, but the Chinese lack a similar arsenal. They are currently left with the punitive measure of banning rare earth metal exports to the United States, which could disrupt major tech supply chains.
Overall, net trade with China is in decline, and banking sector risks are mounting. This may put pressure on the yuan, which would risk global economic growth. China’s contribution to Global GDP growth is 33%, and if you include the rest of Asia, that number becomes roughly 63%. As an investor, my hope is that trade war concessions come, the United States and China come to a deal, and the currency stays stable.
With all the risks mentioned, investors should step back and look at the economy as a whole. Personal income increased in April. First quarter GDP grew by 3.1%. Jobless claims hit an all-time low in April as the unemployment rate is near a 50-year low. Consumer sentiment is also near a 15-year high. Analysts are also anticipating market growth at 6% to 8% for the year. U.S. economic fundamentals remain strong, albeit amongst a riskier global outlook.
I’ll end by saying there are areas of the market that remain attractive and a number of areas that appear expensive. The best choice for investors is to stay the course. Keep the money you need within the next 10 years in fixed-income investments held to maturity to protect principal. Invest the money you do not need within the next 10 years in the stock market for growth.