News flow has turned ugly again, but equity markets are a long way from irrational exuberance.

These were supposed to be the relatively quiet “dog days” of August.

July set us up with better-than-expected U.S. second-quarter earnings results, strong U.S. retail sales data, a strong nonfarm payrolls report and a robust set of numbers that appeared to show China establishing a bottom in its growth slowdown.

For sure, investors didn’t like it much when the Federal Reserve gave them only a 25-basis-point rate cut and a mangled message on policy intentions on the last day of the month. But August opened with another strong print in U.S. jobs data and much better-than-expected retail sales results from Europe, underlining the sense that, notwithstanding a palpable slump in manufacturing, the region’s consumers are feeling confident enough to keep the economy chugging along.

Trade War or Currency War?

Nonetheless, the month wasn’t a day old before it started mixing another volatile summer cocktail of disruptive news flow and patchy market liquidity. It has given investors two new developments in particular to come to grips with.

The first is a sudden change in U.S. tariff policy that has taken the U.S.-China trade skirmish to a whole other level.

The notion that there may not be a trade deal at all, but instead an ever-escalating trade war, jolted the market. This is a tough one to handicap given the mercurial nature of the current U.S. administration. We remain of the view that a trade deal “lite” will eventually be achieved, but that the conflict over technological supremacy is likely to rage for years.

The second is the idea that when China decides to stop intervening to support its currency, that makes it a currency manipulator.

In fact, China has been biased to supporting the renminbi for years because it is more concerned with maintaining foreign capital inflows than it is with a few basis points here or there in GDP growth.

Even if it were depressing its currency, China would face stiff competition from what looks like a global currency race to the bottom. Every major economy is shifting policy to stimulate domestic activity by further lowering rates and gaining a competitive currency advantage. The White House itself has not been shy about leaning on the Fed to prime the pump. It can sometimes look as though China is the one country seeking a stable exchange rate.

Volatility May Be Here to Stay

As the rhetoric got heated last Monday, markets responded violently. The main U.S. equity indices gave up around 3%, their worst day of 2019. Bond yields fell dramatically worldwide, and curves flattened. We know that lower rates can be stimulative, but at some point investors may begin to wonder whether these yields are pricing in a downturn, leading to further selling in equity markets. It would be easy to conclude that last Monday was the start of a sizable correction for a market that had gone way over its skis.

But are risk assets really that vulnerable? Valuations appear fair following the latest earnings releases, and the major sell-off in December may be creating an optical illusion as to just how far equities have risen this year.

Look at 12-month returns to the close of the volatile session last Monday, and you may be surprised to see that the S&P 500 was up by only 1.8%. European equities were down more than 1%, and emerging market equities were down almost 4%. The Russell 2000 Index of U.S. smaller companies was down by double digits. 

Having to dodge geopolitical trade and currency surprises is far from helpful, and uncertainty around these matters is a large part of what is holding back global growth at the moment. Volatility may be here to stay. But markets do not seem to be irrationally exuberant—to borrow the old phrase from Alan Greenspan—and that could give investors some comfort to remain focused on those decent earnings, jobs and consumption data, and on central banks’ preparations for some modest, mid-cycle easing.

In Case You Missed It

  • ISM Non-Manufacturing Index: -1.4 to 53.7 in June
  • China Consumer Price Index: 2.8% year-over-year in July
  • U.S. Producer Price Index: +0.2% in July month-over-month and +1.7% year-over-year

What to Watch For

  • Tuesday, 8/13:
    • U.S. Consumer Price Index
  • Wednesday, 8/14:
    • Euro Zone 2Q 2019 GDP (Second Estimate)
  • Thursday, 8/15:
    • U.S. Retail Sales
    • NAHB Housing Market Index
  • Friday, 8/16:
    • U.S. Housing Starts and Building Permits

– Andrew White, Investment Strategy Group

Statistics on the Current State of the Market – as of August 9, 2019

Market Index WTD MTD YTD
S&P 500 Index -0.4% -2.0% 17.8%
Russell 1000 Index -0.4% -2.1% 18.2%
Russell 1000 Growth Index 0.1% -1.5% 22.4%
Russell 1000 Value Index -0.9% -2.7% 14.1%
Russell 2000 Index -1.3% -3.9% 13.1%
MSCI World Index -0.6% -2.3% 15.3%
MSCI EAFE Index -1.1% -2.9% 9.8%
MSCI Emerging Markets Index -2.2% -5.3% 3.7%
STOXX Europe 600 -0.7% -2.9% 10.4%
FTSE 100 Index -1.6% -3.9% 11.2%
TOPIX -1.9% -3.9% 2.0%
CSI 300 Index -2.9% -5.1% 23.2%
Fixed Income & Currency      
Citigroup 2-Year Treasury Index 0.2% 0.5% 2.8%
Citigroup 10-Year Treasury Index 1.1% 2.6% 10.2%
Bloomberg Barclays Municipal Bond Index 0.6% 1.1% 7.1%
Bloomberg Barclays US Aggregate Bond Index 0.6% 1.3% 7.8%
Bloomberg Barclays Global Aggregate Index 0.8% 1.4% 6.8%
S&P/LSTA U.S. Leveraged Loan 100 Index -0.4% -0.4% 7.4%
ICE BofA Merrill Lynch U.S. High Yield Index -0.3% -0.7% 9.9%
ICE BofA Merrill Lynch Global High Yield Index -0.1% -0.5% 9.3%
JP Morgan EMBI Global Diversified Index 0.8% 0.7% 13.5%
JP Morgan GBI-EM Global Diversified Index 0.5% -1.1% 8.5%
U.S. Dollar per British Pounds -0.3% -1.4% -5.2%
U.S. Dollar per Euro 0.9% 0.6% -2.0%
U.S. Dollar per Japanese Yen 0.9% 2.8% 3.8%
Real & Alternative Assets      
Alerian MLP Index -4.2% -5.9% 9.8%
FTSE EPRA/NAREIT North America Index 1.4% 1.5% 20.4%
FTSE EPRA/NAREIT Global Index 0.0% -0.3% 15.3%
Bloomberg Commodity Index 0.3% -1.9% 2.4%
Gold (NYM $/ozt) Continuous Future 3.5% 4.9% 17.7%
Crude Oil (NYM $/bbl) Continuous Future -2.1% -7.0% 20.0%

Source: FactSet, Neuberger Berman.