Capital markets remained volatile following an escalation in ongoing trade policy tension between the United States and China. While markets appeared shaky Sunday evening and heading into Monday trading, China responded to U.S. tariffs that were announced and implemented last week with a tariff plan of their own that will start on June 1. Those duties will affect over 5,000 items exported by the United States to China. Further upping the ante, the United States is expecting to detail a plan to administer 25 percent levies on all remaining Chinese imports early this week. Investors are concerned that the breadth, depth and duration of potential tariffs may threaten economic growth and corporate earnings, resulting in broad selling pressure across traditionally riskier parts of global assets.
Since reaching all-time highs less than two weeks ago, U.S. large-cap equities are off by 4.5 percent. Over that same period, and through today’s close, emerging market equities have fallen by 7.6 percent, foreign developed equities are off 4.4 percent, commodities are down 2.8 percent and high yield bonds are off 1.3 percent. However, other components of a diversified portfolio still appear to be working — “core” bonds are up 0.5 percent, municipal bonds are up 0.8 percent, long-duration bonds are up 1.9 percent and real estate investment trusts (REITs) are up 0.4 percent.
So how do the recent developments impact our views on the forward investment landscape? Given uncertainty surrounding how long the current U.S.-Sino impasse may last, the capital market reaction appears justified, although it could quickly become overdone. Sectors that have become flashpoints between the United States and China — namely Information Technology, Consumer Discretionary and Industrials — felt the brunt of today’s selling pressure, indicating that capital markets remain very news-dependent and that investors had anticipated a trade deal as a fait accompli just a few weeks ago. However, our chief concern centers on weakening economic momentum prior to unravelling trade negotiations. Our systematic data checks, which span over 700 economic variables, have registered a slowdown, albeit from a strong base. Recall that in 2017 and early 2018, the prevailing capital market narrative was one of “synchronized global growth.” However, in early 2018, China began to weaken, as did Europe and Japan, and eventually North America followed suit.
Should the trade war persist, CEOs, CFOs and consumers may slow down expansion and consumption decisions, which could exacerbate what we still forecast as a gradual slowdown. That has not yet happened, and we are carefully monitoring indicators that would suggest that the growth picture could weaken from here. While we must respect this adverse case, note that we characterize the trade war as an “edgeless” phenomenon, meaning it is very difficult to forecast or handicap its outcome, including terms and timing. No matter how many people appear in the press as policy experts, these negotiations could end at any time or they could go on longer than anyone anticipates. Further, market volatility can create many opportunities, which we constantly evaluate.
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Equity securities are subject to stock market fluctuations that occur in response to economic and business developments. International investing involves special risks, including foreign taxation, currency risks, risks associated with possible differences in financial standards and other risks associated with future political and economic developments. Investing in emerging markets may involve greater risks than investing in more developed countries. In addition, concentration of investments in a single region may result in greater volatility. Investments in fixed income securities are subject to various risks, including changes in interest rates, credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications and other factors. Investment in fixed income securities typically decrease in value when interest rates rise. This risk is usually greater for longer-term securities. Investments in lower-rated and non-rated securities present a greater risk of loss to principal and interest than higherrated securities. Investments in high yield bonds offer the potential for high current income and attractive total return but involve certain risks. Changes in economic conditions or other circumstances may adversely affect a bond issuer's ability to make principal and interest payments. The municipal bond market is volatile and can be significantly affected by adverse tax, legislative or political changes and the financial condition of the issues of municipal securities. Interest rate increases can cause the price of a bond to decrease. Income on municipal bonds is free from federal taxes but may be subject to the federal alternative minimum tax (AMT), state and local taxes. There are special risks associated with an investment in commodities, including market price fluctuations, regulatory changes, interest rate changes, credit risk, economic changes and the impact of adverse political or financial factors. Investments in real estate securities can be subject to fluctuations in the value of the underlying properties, the effect of economic conditions on real estate values, changes in interest rates and risks related to renting properties (such as rental defaults).