Investor optimism versus tariff fears --
A domestic view

11.08.18

Despite the constant headlines about global trade tensions, investors appear to be weathering current market volatility and are opting to focus on the robust U.S. economy, sound corporate earnings and healthy job market. Even with volatility noise, we think the U.S. market can continue to run, assuming we can avoid a full-blown trade war, rapid wage hikes for U.S. workers and a surprise boost in inflation.

Investor optimism driving market momentum

Investor optimism about U.S. stocks has been related to the outlook for corporate profits. Earnings growth has been extremely strong this year — thanks to the Tax Cuts & Jobs Act of 2017. Domestic growth has generally lived up to expectations, despite commodity price weakness, U.S. dollar strength and U.S. Federal Reserve (Fed) tightening. Both consumers and businesses remain confident as beneficiaries of the strong growth environment.

U.S. markets strong even with volatility

For most of the year, the major U.S. indices have been on an upward trend. While U.S. stocks powered higher to records while the rest of the globe’s markets fell apart, many in the investment world wondered if the domestic run would last. Enter October 2018. Market volatility during the month spiked to an unprecedented level. It wasn’t all bad news, volatility and huge sell-offs were intermixed with strong gains, including a 548-point jump by the Dow Jones Industrials Average on October 16 and another 400-point gain on October 25. The last day of the month ended on an up note as well with a 241-point rally by the Dow. Amid all the concern, year-to-date metrics have been solid and 2019 expectations have actually pushed a bit higher over the past few weeks. In addition, macro commentary on recent corporate earnings calls has been fairly upbeat.

Despite the October volatility surprise, we believe investors still have plenty of reasons to stay optimistic, including:

  • Strong gross domestic product (GDP) growth in third quarter of 3.5% and predictions for another positive number in fourth quarter.
  • Growing employee wages, including a boost in the private sector minimum wage.
  • A robust labor market.
  • Strong overall corporate earnings.
  • The U.S., Canada and Mexico trade dispute resolution.
  • Inflation expectations that appear to be contained.
  • Slow growth in China that could drive positive trade talks with the U.S.

Tech, consumer discretionary, and health care performing best YTD

This chart illustrates how the S&P 500 and its sectors have performed year to date Jan. 1, 2018 through Sept. 30, 2018.

This chart illustrates how the S&P 500 and its sectors have performed year to date Jan. 1, 2018 through Sept. 30, 2018

Ivy's domestic outlook

We believe the strong U.S. market has the potential to last awhile longer amid continuing strong economic activity and vigorous unemployment numbers. But this assumes additional tariffs don’t grow into a full trade war, rapid wage hikes and faster inflation don’t materialize.

Below we provide our thoughts on domestic and foreign economic growth, interest rates and commodity prices.

Domestic economic growth

Our outlook has been the same for some time and we still expect continued solid growth for the U.S. economy. We believe the benefits of recent tax reform are still working through the economy and should allow for continued economic expansion. Confidence levels are strong for consumers and corporate executives, alike, driving spending and investment. Any change in tone or an increase in uncertainty regarding tariffs over the coming earnings season could affect markets and the economy. The current trend in housing is one area that we are watching closely. The housing market seems to have hit a slower patch for both new and existing home sales according to recent reports. This situation has created heightened awareness for concern given housing’s impact in the broader economy. As we transition into 2019, we expect some moderation in domestic economic growth, but believe it will still be solid.

Foreign economic growth

Of all the potential outcomes from President Donald Trump’s policies, the impact on foreign economies is by far the murkiest of all the issues. Sometimes rhetoric is just rhetoric, but we have seen some action on trade issues. On the positive, we have a new trade agreement with our bordering countries in North America, the U.S.-Mexico-Canada Agreement. This gives us some comfort that Trump has been effective in improving the positioning of the U.S. On the negative, U.S. and China appear to be locked in a staring contest, with no sign of either party wanting to blink first. Tough talk has led to tariffs, which then were met with countervailing tariffs, and so on. These tariffs are likely to negatively impact global growth rates and it appears to be showing itself with slower Chinese economic growth. China could stimulate demand and that is the likely outcome at this point, but we are increasingly concerned tariffs will impact both confidence levels and underlying growth. Prospective and currently owned companies are under increased scrutiny regarding their understanding of supply chains and geographic exposure.

Interest rates

The Federal Reserve has raised rates seven times in three years in a bid to begin to normalize the interest rate environment and to head-off anticipated inflation. Markets typically get a bit of indigestion as the tightening cycle ensues. That indigestion has become acute on the news of continued strong job growth, with rates rising more quickly and to levels not seen since 2011. We continue to see the near-to-intermediate term positives outweighing the concerns over rates and trade tensions, although the rate environment is more concerning to us in the intermediate term than it has been for some time, especially given the valuation levels on many long duration, high-growth stocks. We see the rate trends at this point in the cycle as a reflection of economic vitality, and not yet a challenge to growth, but the recent rate of change is causing a valuation adjustment in much of the market as investors reassess the horizon.

Commodity prices

Broad commodity prices have moderated from a strong climb to start the year. We have been surprised with the increase in oil prices in 2018, but have not changed our broad stance, which is as prices rise, oil shale producers can quickly respond creating a counterbalancing force on any significant appreciation. Near-term infrastructure constraints appear to have added a new wrinkle to the ability to quickly respond with supply growth. We believe given the resourcefulness of this industry and currently high prices, the constraints can be circumvented. Finally, infrastructure is being built so while supply may remain tighter over the near term, our investment horizon looks beyond where we see ample infrastructure forthcoming. Beyond oil, tariffs have the risk of adding to some of the already present inflationary pressures in the economy, but we think these issues are manageable. Companies we own and those potential prospects are under close scrutiny for their ability to pass on higher costs so margins do not compress.

In summary

Market volatility is something we watch closely; however, our primary focus will be on business model fundamentals. While macro selloffs will always be a cause for concern, we will adjust accordingly if the companies we invest in become significantly stressed due to fundamental changes.

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Past performance is not a guarantee of future results. The opinions expressed are those of Ivy Investment Management Company, are current through November 2018 and are subject to change at any time based on market and other current conditions. No forecasts can be guaranteed. This information is not a recommendation to purchase, sell or hold any specific security mentioned or to engage in any investment strategy. Strategies or securities discussed may not be suitable for all investors.

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