July 2018 – Monthly Commentary
July 2018
The dog days of summer are upon us and the U.S. market has been relatively calm despite the daily barrage of news from around the globe. That’s not to say that global macro events are not on the mind of investors. Quite to the contrary. Donald Trump’s trade war is making the headlines daily, the health of the European banking system continues to be a worry, and the drama of The United Kingdom’s divorce from the European Union is entering its third year with no agreement in sight.
Also on the minds of investors is the continued collapse of emerging market economies and the value of the currencies that they represent. Quite often Investment advisors recommend emerging market debt as a way to diversify risk and add yield to a portfolio during times of calm. We’ve written on numerous occasions that the additional yield is not worth the added credit risk. The history of emerging market default is long and painful. At the time of this writing, the Turkish lira is in freefall due to the political missteps of their questionably elected leader and his attempt to manage monetary policy. Similarly, Russia again finds itself in the midst of a currency crisis based on the sanctions imposed by the United States. While that has pushed the value of the Ruble lower, the Russian economy is heavily dependent on oil revenue, and with the elevated level of oil prices the fallout is not nearly as bad as that of Turkey.
Also dragged down with the other emerging economies, the currencies of Korea, Thailand, and Singapore have all fallen versus the U.S. dollar. The driver behind the Asian currency selloff is decidedly China. The value of the Chinese Yuan versus the U.S. dollar is managed by the deep-pocketed Chinese government and has fallen nearly 8% in the last two months despite strict currency controls. The Chinese government claims they are taking steps to slow the decent of the Yuan but it continues to lose value. We believe that the devaluation is a thinly veiled attempt to retaliate against the tariffs put in place by the Trump administration. Just three years ago, the International Money Fund elevated the Yuan to World Reserve currency status and yet the Chinese government continues to manipulate its value. While not surprising, the IMF and its Chair, Christine Lagarde, have been mum on the subject.
As we wrote earlier, despite the perpetual diet of news, markets are enjoying a relatively quiet summer, with the S&P 500 index sitting just below an all-time high. That performance comes on the back of another terrific earning season in which sales grew 11%, and operating income rose an “eye-popping” 26% versus Q2 2017 results. What’s been conspicuously absent this season is the idea of “peak earnings” the media embraced to describe surprisingly strong Q1 earnings. Were pundits embarrassed to have gotten the call wrong or has investor sentiment changed and the opinion is now that the U.S. economy has shifted into high gear? We’re of the opinion that it’s a little bit of both. The tax cuts enacted late last year are absolutely contributing to bottom line growth as corporations are paying less in taxes. Moreover, they’re likely to support year-over-year growth for the rest of 2018 until comps become more challenging in April of 2019.
As the summer comes to a close and investors return to their trading desks, we expect that volatility will return. The question, as always, will it be upside volatility or downside?