With the Labor Day holiday coming up, as of now (even after Friday’s downturn) the equity market is on pace to debunk (slightly) the myth of “sell in May and go away.” This is the fourth year that the S&P 500 has been positive from memorial day to the labor day holiday. That does not mean it was a smooth ride (and not over yet!). This summer the S&P 500 saw its second worst drawdown over the past five summer holidays (~-6%). In addition, this August was eerily similar to four years ago (2015) when China devalued their currency and sent the equity markets spiraling lower. With the summer coming to an end and with all the uncertainty in the markets, we outline five things outside of the trade war that we are watching as we move to the end of 2019.
#1 Democratic field to narrow. As of now there are 21 candidates running for the 2020 Democratic Presidential nomination. At this point, two debates are scheduled for September but only 10 candidates satisfy the requirements to participate. This Wednesday, August 28th, is the cut off for candidates to qualify for the September debate. If by the deadline only 10 candidates qualify, the second debate may be canceled and the field could narrow further. One debate is scheduled for each month for the remainder of 2019.
#2 Brexit – Yay or Nay? The UK is set to leave the EU at the end of October and the likelihood of a hard exit is rising. The UK Prime Minister, Boris Johnson, is at a standstill with EU officials given his hard line on removing the Irish backstop. With no other option in place at this time, EU and UK officials have stated that a “no-deal Brexit” is becoming the base case scenario. The pound has lost ~15% of its value since its recent peak (June 2018) and the FTSE 100 has underperformed U.S. (S&P 500) and global (MSCI AC World) equities by over 700 bps in that time frame. Therefore, it is difficult to say that investors are not pricing in this scenario. While recession odds will increase with a “no-deal” exit, it opens the door for bi-lateral trade negotiations, especially with the US.
#3 Central banks to be the main focus in September: The Bank of Canada (Sept. 4) kicks off the September wave of central bank meetings. Some other important meetings to focus on are the ECB (12th), FOMC (18th), Bank of England and Bank of Japan (19th). Investors are looking for a globally coordinated easing cycle and any tone that is not perceived as dovish could hamper risk sentiment. In addition, we may see some central banks and governments open the door for additional nontraditional policy measures and/or fiscal stimulus. For example, Germany has been rumored to be weighing a major fiscal stimulus plan if growth deteriorates further. The Fed funds futures market shows a 100% chance of a 25 bps rate cut in September but there have been conflicting comments from Fed officials about the need and amount of rate cuts warranted. Speculation on the Fed’s moves will likely continue to drive risk sentiment and keep volatility heightened.
#4 3Q19 earnings season: Earnings seasons always have the chance of fueling volatility but when the 3Q19 season kicks off the week of October 14th, we will be looking for insights from corporations in regards to the negative ramifications from the recent tariffs. Their outlook on spending and hiring are important to the outlook for economic growth.
#5 Intervention in the dollar? The strength in the U.S. dollar has been a focus of the President, especially in his criticism on the pace of the Fed’s actions. The USD has increased over 10% since the beginning of 2018. While a strong currency should be viewed as a positive, it can also be deflationary, hamper multi-national profits and reduce competitiveness. However, interest rate cuts alone in a world where other central banks are adopting a zero interest rate policy may not have the same negative impact on the dollar as you may see in a normal global interest rate environment. If the dollar strength persists and continues to frustrate President Trump, he could announce steps to try to weaken the dollar. The White House has stated any intervention has been “ruled out,” however if growth is threatened by the strength in the dollar, we would not be surprised to see Trump act on the dollar. Some options include selling dollars and buying other currencies using the Treasury’s Exchange Stabilization Fund and/or imposing a currency transaction tax. However, intervention in the currency market is dangerous and can have indirect and long lasting negative effects so we are hopeful it does not go that far.