Are trade worries a reason to exit the market?
US-China trade talks have taken a negative turn. The US raised tariffs on USD 200bn of Chinese imports. In return, China has said it will retaliate. While we ultimately expect a successful outcome to talks, risk asset volatility will remain high until there is further clarity. The direction of markets over the coming months now looks likely to hinge on whether talks can get back on track. We are starting to see signs that the uncertainty is taking a toll on global growth and business investment.
Can the US equity rally continue?
The S&P 500 has suffered a setback since hitting a record high in late April. Trade tensions with China have caused the index to retreat as much as 5% as investors await news on whether a deal can be reached. We believe that US equities can continue to move higher, and maintain our six-month outlook for the S&P 500 target level of 2,950, or about 4% above current levels. Our base case remains that the US and China will strike an agreement on trade. From a fundamental perspective, US earnings have remained resilient, recession risks remain low, and stocks aren't expensive given current growth and inflation expectations.
Can profit growth support US equities?
Investors have become accustomed to a blistering pace of earnings growth in the US. Recently, however, the momentum has slowed, and there has even been talk of an earnings recession. While we expect growth to be muted in the first half of 2019, a material decline in profits looks unlikely. The slowdown is being exaggerated by a fading boost from US tax reform, as well as idiosyncratic headwinds in a handful of sectors, especially smartphones, semiconductors, and energy. Overall the outlook for the US economy remains positive, and we expect stocks to continue to advance as investors come to appreciate that earnings growth will improve a bit.
Should the yield curve worry investors?
Back in March a part of the yield curve inverted for the first time since 2007. For a few days, the yield on 3-month Treasury bills was higher than the yield on comparable 10-year bonds. The curve corrected itself through April before inverting by around 3bps on 15 May. We see no cause for concern as the inversions are exceptionally shallow and short-lived. An inverted yield curve has only predicted recessions with long and variable delays. It may prove less prophetic this time, since central banks' bond buying has suppressed yields on long-duration bonds. We do not expect a global recession this year.
May's Brexit, slow Brexit, or no Brexit?
Fresh twists in the Brexit saga have become a daily occurrence. Having failed to win approval for her plan from lawmakers, UK Prime Minister Theresa May has been forced to request a further delay to Brexit - which the EU has agreed to push back to October 31. The eventual denouement remains hard to predict, and options range from a no-deal Brexit to a significant delay with no exit at all. Meanwhile, uncertainty over the process remains a drag on business investment both in the UK and Eurozone. Given the difficulty in predicting the final outcome, we do not recommend taking directional views on sterling.
Knowledge is power
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