On Wiggles and Wobbles

Editors’ Note: As always, our political commentary is non-partisan by design. We favor no political party, candidate or elected official in any country and assess politics solely for their potential economic and stock market impact.

Volatility took the stage again Thursday, with the S&P 500 down as much as -1.8% intraday before an afternoon recovery pared the decline to -1.2% in price terms, continuing this month’s pullback.^[i] To us, this looks like a sentiment freakout. Tariff talk and impeachment chatter could be weighing on folks in America, while heightened Brexit chaos and the ongoing European Parliament election could be compounding matters across the pond, contributing to European stocks’ bad day. Or it could be none of those things. Markets can wobble any time, for any or no reason. But unless there is some new, huge, broadly ignored negative development brewing, we think the right move for investors targeting long-term growth is to grit their teeth, avoid rash decisions and remember enduring short-term declines is the price we pay for market-like returns over time.

So let us briefly tour today’s headlines and see if there is anything truly new.

On the economic front, we got IHS Markit’s “flash” Purchasing Managers’ Indexes for France, Germany and the eurozone, which showed German manufacturing lingering near its weakest reading in years and the eurozone just inching along. Headlines zeroed in on the sentiment component of these indexes, warning businesses’ dismal expectations will be a self-fulfilling prophecy. Yet as we have written here often, sentiment isn’t predictive. It is at best coincident, registering how people feel at the moment they take a survey. We don’t doubt companies throughout Europe are feeling blue, what with a run of weak-ish data and constant headlines warning of economic gloom. Yet the actual forward-looking component—new orders—looked alright. Eurozone new orders slowed but remained in expansionary territory, according to IHS Markit’s press release. France’s new orders accelerated even as export orders contracted for the seventh straight month. German manufacturing orders contracted, but services new orders grew. No, these results aren’t gangbusters. We don’t expect eurozone growth to suddenly shoot higher. At the same time, the evidence points toward continued growth, not abject doom—and the results are largely in line with what we have seen in Europe for the past few months. In other words, not suddenly new weakness, just more of the same, which eurozone GDP growth has already shown isn’t recessionary.

Tariffs and China remain the dominant US story, but here too, we mostly see the status quo. Both sides are ratcheting up their rhetoric, consistent with how they have handled these negotiations from the start. It appears to be all about leverage, with both teams referencing The Art of the Deal as they posture ahead of President Trump and President Xi Jinping’s mooted meeting at June’s G20 summit. Meanwhile, Treasury Secretary Steve Mnuchin said it will likely be at least a month before new tariffs on $300 billion worth of imports from China take effect, and US regulators have quietly granted Tech companies a grace period for phasing in the Huawei ban. We don’t pretend to know what is going on in anyone’s head here, but it seems to us that if these tariffs and sanctions were about something other than leverage—if they were actually about protectionism—their implementation wouldn’t be so wishy-washy. They would be in place, and they would be far bigger and tougher than what the administration has already proposed. As it stands—and as we showed here last week—if all these Chinese tariffs (including retaliation) take effect, tariffs would total $146 billion, which sounds huge but is only 0.43% of combined US and Chinese GDP. We don’t dismiss the potential impact on certain industries, particularly agriculture, but markets generally understand that a tax increase this small doesn’t cause recessions.

As for the other US political headline—impeachment rumblings—we won’t even begin to handicap the likelihood of a House vote. Doing so would be impossible, as it isn’t a market function. Too much political inside baseball, too much gamesmanship. However, we can point you to our past analysis of the stock market’s limited history with impeachment to show that, even if this does happen, it isn’t automatically bearish. Stocks did fine during President Clinton’s impeachment trial. Actual impeachment proceedings would stir chatter and perhaps heighten uncertainty, which could weigh on sentiment. Or markets could be pre-pricing this now. There is just no way to know. But based on all the information available today, and considering a Republican Senate didn’t vote to oust Clinton after he was impeached, it looks like a conviction of a Republican president by a Republican Senate today would be an extremely tall order.

Moving on to overseas politics and the “B” word—Brexit—at the risk of oversimplifying, the larger situation remains the same. Proceedings are still messy, with no end in sight. UK Prime Minister Theresa May still hasn’t announced her departure date, and as we write, it remains unclear whether her Conservative Party will force her hand. Both they and the opposition Labour Party are bleeding support to the upstart Brexit Party as well as the resurgent Liberal Democrats. No one knows yet what the next EU withdrawal bill will look like, whether it will include a provision ordering a vote on a second Brexit referendum, or whether lawmakers will pass it. In short, there is more chaos, but the actual potential outcomes and status quo of uncertainty haven’t changed. Nor has our opinion that the best tonic for UK markets, at this point, would be any resolution at all. It would end the uncertainty and enable businesses, markets and everyday people to move on.

Lastly, the European Parliament elections. You can see Monday’s commentary for our full analysis, but in short, it seems all the chatter about ascendant populists is roiling sentiment. We have seen headlines arguing it will spell the end of the EU’s push for free trade, the rise of more internal roadblocks, the stalling of potential reforms and more. Yet to us, it seems the likeliest outcome is just more gridlock, which is a fine thing for markets. Once the dust settles and this becomes apparent, we suspect sentiment should improve, helping unleash pent-up demand.

Now, none of this is to say stocks will bounce immediately. Short-term volatility is unpredictable. The skid could stop soon, or it could turn into a correction (a sharp, sentiment-driven drop of around -10% to -20%). If that happens, remember corrections are normal. Remember how strongly stocks bounced after last year’s correction, with the S&P 500 recovering in a near-perfect “V” shaped pattern. Remember it is always darkest before the dawn. Most importantly, remember your long-term goals and the discipline and patience necessary to reach them.