While Jim is away on vacation, other members of the TBA Investment Committee will write the market comment. Today’s comment is from Chris Gildea.
The latest bout of volatility was ignited by news that U.S. government regulators are now targeting some of the largest tech companies on antitrust concerns. Whether or not any concrete actions are taken, investors shaved nearly $140 billion of combined market value off the FAANG stocks on Monday. These losses were largely reversed on Tuesday as the S&P 500 rallied 2.1% following Fed Chairman Jerome Powell’s statement that “we will act as appropriate to sustain the expansion” in light of “recent developments involving trade negotiations.”
Chairman Powell’s statement came on the heels of weak economic reports and escalating trade tensions. On Monday, the ISM manufacturing index for May was reported at 52.1, down 0.7 from April’s 52.8 and compared to expectations for a reading of 53. Even worse, the U.S. Manufacturing Purchasing Managers’ Index fell by more than 2 points to 50.5 in May which was the lowest reading since September 2009 during the global financial crisis.
The yield on the benchmark 10-year U.S. Treasury note is now at a 20-month low of 2.1% which indicates that fears of a decline in global growth have accelerated. Moreover, St. Louis Federal Reserve Bank president James Bullard commented that a rate cut “may be warranted soon” which supports investors’ forecasts that the Fed will soon start cutting interest rates to prevent a recession. Add to this President Trump’s decision to end preferential trade treatment for India not to mention the ongoing trade wars with China and possibly Mexico and Europe. The result is a rocky start to June following an almost 7% decline in the S&P 500 during the month of May.
So, why is the 10-year U.S. Treasury yield approaching 2%? Are U.S. interest rates simply too high compared to those in other regions of the world? Is it because we are about to enter a recession? Or is it simply a reflection of low inflation expectations? This is the question that investors and market prognosticators are seeking an answer. On one hand, economists tell us that trade wars will cause inflation as companies increase prices to offset rising costs of imported goods. Alternatively, rising costs and tariff uncertainty may cause businesses to curtail investments and consumers to spend less which will result in a recession. And, maybe it is simply the realization that U.S. bond yields were simply too high compared to global interest rates so investors have scrambled to buy as much as they could. It is likely a combination of these things.
As far as the recent news that U.S. regulators are targeting the tech behemoths, antitrust concerns are not new and have been an ongoing topic of discussion for investors. The primary concern for regulators is not that each has achieved a “monopoly” status, but rather the “monopoly” is being preserved through actions that are preventing a competitive marketplace from developing. However, it is too early to determine whether the government probes will produce actionable evidence of anticompetitive behavior, much less whether an order to break up the companies would actually impair their valuations. We expect more volatility for the FAANG stocks as this matter will not be resolved anytime soon. Ultimately, a case-by-case analysis is needed to determine probable outcomes taking into account the political landscape. With both political parties in apparent agreement that more scrutiny is necessary, we can only assume that headline risk will remain a factor as we enter a period of escalating rhetoric in advance of the 2020 election.
So, what does all this volatility mean for long-term investors?
Make sure your asset allocation is appropriate because attempting to time the market often results in sub-par results. There will always be economic and political uncertainties and surprise events that cause the prices of stocks and bonds to fluctuate wildly as we all know. Armed with knowledge, these periods create opportunities to identify high-quality companies that have durable competitive advantages and operate in industries with superior long-term economic characteristics that can be purchased at below fair value prices. If the economy does soften as global interest rates and Fed comments imply is possible, upgrading portfolio quality will provide an added layer of protection.
Chris Gildea, 610-260-2235