August 7, 2019

U.S. stocks have hit another trade-induced summer storm

The S&P 500 Index fell 3% on Monday, its worst day since December 2018. The index is now about 5% from the recent record highs in U.S. stocks. This week has been the worst bout of volatility since May.

As we are all aware, but often need to be reminded - Storms Happen Often in U.S. Stocks, Although stock volatility this year has been relatively subdued compared to history, the S&P 500 has averaged an annual decline of 14% from peak to trough since 1990.  In fact, even in years that the stock market ends up positive, the index has dropped an average of 11% at some point during the year.

Though the volatility can be uncomfortable, it’s normal for U.S. stocks to endure periodic pullbacks. These experiences typically provide opportunities for suitable investors to rebalance, diversify portfolios toward targeted allocations, or to add to equity positions based on what we see as a generally favorable macroeconomic environment.

Stocks’ recent sell-off has been especially brisk. Just 10 days ago on July 26, the S&P 500 reached a new all-time high, bolstered by the hope of a rate cut by the Federal Reserve, improving economic data, and cooling trade tensions. Since then, the Fed’s rate cut and messaging wasn’t met with investor enthusiasm, the United States threatened tariffs on $300 billion in Chinese goods, and China pulled prior commitments to purchase U.S. agriculture goods. In addition, China’s central bank let its currency (the yuan) fall below the key 7 per dollar level that some view as a line in the sand relative to currency manipulation.

That being said, the fundamental picture for stocks hasn’t really changed all that much. Economic growth has exceeded expectations, inflation and interest rates are low, and second quarter earnings have been better than expected. Trade uncertainty continues to weigh on global markets, but tariffs haven’t significantly affected the domestic economy and the Fed has indicated willingness to loosen policy as needed. While there are still geopolitical risks, including trade, a review of all of the above fundamentals suggests to us that the odds of an imminent recession are quite low.

Of course, we will continue to watch the trade front and monetary policy, along with their impacts to the U.S. dollar, economic output and corporate profit growth. For now, we see few reasons that suggest this market pullback will result in anything more than a typical correction.

It’s important to remember that the stock rally is still intact, and pullbacks like the most recent one are normal events over the long term. While near-term volatility can be uncomfortable, it has helped curb excesses in the markets and sustain healthy sentiment, allowing for what is now the longest bull market on record. Volatility may also provide opportunities for suitable investors to rebalance, diversify portfolios toward targeted allocations, or add to equity positions.