Markets ended July 31st with a sudden 1% drop in the S&P 500, closing lower several short hours ago after the Federal Reserve announced their decision to cut interest rates by 25 basis points. For those not closely following these developments, the market had expected the Fed to cut interest rates, but had also hoped for a blueprint to further rate cuts. A decently strong jobs report earlier this month elicited a similar negative reaction, placing the market into that old mindset that “good news is bad news.” Basically, investors are watching the Fed and hoping for an increase in the money supply (by stepping back some of last year’s interest rate hikes), which – all else equal – would force liquid assets to move further out on the risk curve in search of yield (this means more money moves into stocks).
Strangely enough, this time US equity markets are sitting near record highs with a backdrop of solid (domestic) economic data. The Fed's “midcycle adjustment” therefore seems to be the most prudent course of action, ceteris paribus (read more about the Federal Reserve’s decision to cut rates at the Financial Times). President Trump had recently been weighing in on the Fed’s decision-making process, publicly pressing for rate cuts. Federal Reserve Chairman Powell, conversely, has been facing the unenviable prospect of making necessary monetary policy decisions while maintaining the optics of an independent Fed.
But the Fed meeting and July is now ending, with August approaching in a few short hours. Below are some highlights that investors may want to keep an eye on for the coming month.
Earnings
Second-quarter earning season is now in full-swing and more than half of the S&P 500 component companies have reported their own results. Now that the tailwinds from the December 2017 tax cuts have long since exhausted themselves, peak earnings have again become a real concern amid relatively tame wage growth, high levels of employment, and elevated trade tensions. However, a large majority of S&P 500 companies have managed to once again beat analysts’ low expectations for the quarter.
Investors are now digesting how well various companies are dealing with trade and other headwinds and whether recent strength seen in some quality names can continue going forward. As Warren Buffett is quoted as saying, “You only find out who is swimming naked when the tide goes out.” As several sectors continue to experience weakness, underperforming companies in these sectors have sold off (energy and retail contain many good examples here). The converse to this statement is also true, and The Ignorant Investor himself has identified several companies that have been performing well despite falling under the retail category- an area that should still be generally avoided for now because of widespread exposure to US-China trade tensions (ie many retail items are manufactured in China).
Trade
The détente following a meeting between US President Trump and Chinese President Xi on the sidelines of the G-20 summit in Osaka, Japan, at the end of June set the stage for the market to look beyond trade tensions. Hopeful but wary optimism resulted from that meeting. Wariness since President Trump has demonstrated a willingness to use tariffs as a very blunt instrument, perhaps as an instrument of policy, or perhaps for gamesmanship at the negotiating table. Wariness also since investors aren’t sure which game China is playing- wait out the next US presidential election cycle while using delaying tactics, or negotiate a quick and fair end to the trade disputes.
In early July, the Trump administration threatened to impose tariffs for European goods over aircraft subsidy disagreements. Then, several weeks later and after reaching a trade tension détente with President Xi, President Trump (again) openly mused about placing tariffs on all Chinese imports to the USA. Just yesterday, President Trump accused China of not honoring its agreement to buy more US agriculture products.
Until a concrete agreement is reached, investment exposure to sectors and companies affected by US-China trade disputed should remain limited. Please note that the performance of the Energy Sector is increasingly affected by US-China trade tensions through oil prices and global economic growth fears.
Health Care: Rising Political Risks
While mostly shielded from both trade tensions and economic growth fears, Health Care’s political risks are fast rising. The cost for health care in America has come under heavy public criticism in recent years and has become a political football for all US presidential candidates, including the incumbent, President Trump (read about how the Democratic contenders differ on health care at ABC). As the US presidential election fast approaches, investors widely expect for public scrutiny to increase on this sector as debates intensify.
Drug prices, which affect biotechnology and pharmaceutical names within the Health Care sector, have also received heavy criticism. In July, President Trump’s administration proposed several additional approaches to lowering drug prices in the USA and walked back on another in favor of a legislative solution that is currently making its way through a bipartisan Congress (read more about the bill's details at CNBC). Please note that The Ignorant Investor lists President Trump's proposals here since the sitting US President may push for these changes before the upcoming presidential election.
- Peg US drug prices to international drug prices.
- Allow US consumers to import drugs to the USA from Canada.
- Require hospitals to reveal drug prices to patients.
- Require drug companies to list prices in TV advertisements.
- Prohibit Medicare from paying certain rebates on drugs [Walked back, temporarily].
Technology: Rising Political and Regulatory Risk
Technology is another relative safe haven that is under distant yet looming pressure. Some US politicians and presidential candidates have openly discussed “breaking up” large technology companies like Amazon, Google, and Facebook, with critics citing everything from the platform’s ability to influence politics to potentially harming consumers by limiting competition.
This month, the House Judiciary Committee questioned Apple, Amazon, Google, and Facebook as part of an antitrust probe (read about the potential case to be made against each of these companies at USA Today). Separately, the US Department of Justice is conducting antitrust investigations of several big tech companies while the Federal Trade Commission also reached a $5 billion settlement with Facebook (a small amount for the tech giant, to be sure, which rallied in the aftermath of the announcement before falling in the days after sounding the alarm on potential growth slowdown in its second quarter earnings report).
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As stated many times before, The Ignorant Investor advocates a cautious approach towards equities in 2019. Solid names in sectors that remain relatively safe from the prevailing risks that are outside of the control of the individual investor.
