Equities Prices Are Likely to Continue Churning, But Should Eventually Move Higher
Equity markets struggled to gain clear direction last week. Investors focused on geopolitical issues, particularly U.S./China trade negotiations and the on-again-off-again prospects for a summit with North Korea. Other issues included the sustainability of the U.S. and global economic expansions, rising bond yields, the spike in oil prices and Federal Reserve policy. The S&P 500 Index rose 0.3% for the week. Income-oriented sectors, technology and consumer discretionary led the way, while energy and materials were laggards. Treasury markets also gained ground as the 10-year Treasury yield fell back below 3%.
- Stock prices and bond yields are being held back due to mounting geopolitical risks, especially trade issues. Trade risks remain contained for now, but have the potential to damage the economy and financial markets.
- As long as these risks don’t materially worsen, we think the economic expansion should continue and corporate earnings should improve, which is a solid backdrop for stock prices.
Higher levels of geopolitical uncertainty has caused a rise in market volatility this year. It has also helped keep a lid on both Treasury yields and stock prices, despite the stellar corporate profits backdrop. For the past several months, the main geopolitical issue has been a rise in trade protectionism. Rising protectionism tends to be a lose/lose proposition for all parties. But the Trump Administration seems determined to stick with harsh trade rhetoric, both to call attention to the large and rising current account deficit and to appease the president’s base. The president is eager to point to a political “win” before the midterms, and Chinese officials appear willing to grant modest near-term concessions. The world has avoided a serious trade war so far, and economic sentiment is holding firm. But the situation could escalate quickly.
For now, we think trade-related risks remain contained, but could represent a significant economic and market issue should things change for the worse. For now, we think global financial markets will remain in the current churning range. Assuming the geopolitical backdrop doesn’t worsen and derail the economic expansion, we expect the Fed to continue slowly raising rates, bond yields to climb and the U.S. dollar to firm modestly over the coming months. Treasury yields are experiencing upward pressure in this environment, but are unlikely to break out strongly to the upside since investors remain focused on downside risks.