Confused yet? Stocks have been a mess this week.
The S&P 500 is up only 1.6 percent so far this year, its worst first half showing since 2015. Sectors that were market leaders through most of the quarter — small caps, FAANG stocks, semiconductors — have weakened as the quarter is closing.
While trade issues are still very much present, end-of-the-quarter machinations are likely playing a part in the chaos.
That's because fund managers like pension funds usually have mandates to maintain a certain percentage of their portfolio in specific sectors. Technology has been a big outperformer this quarter, so the tech weighting in many portfolios has substantially increased. Tech has been a substantial underperformer in the past few days, and it's likely a good part of this is due to selling on the part of those who have to rebalance their portfolios.
But that will all go away on Friday. Much broader and more fundamental concerns have given the bears new ammunition:
- Trade war issues are causing concerns that earnings will be cut for industrials, materials, and technology.
- The flattening yield curve has removed the second largest sector — financials — as a leadership group, and with the Federal Reserve expected to raise two more times this year their is a real fear the yield curve will invert.
- Dollar strength is a major worry for corporations with substantial profits overseas. With the U.S. Dollar Index up nearly six percent this quarter, Oracle, Red Hat, and Carnival have warned just in the last week about the negative effect of a stronger dollar on earnings. Emerging market stocks are also down substantially.
- European growth and earnings have slowed dramatically. Earnings for the STOXX 600, roughly the S&P 500 of Europe, are expected to grow in the mid-single digits in the second quarter, compared to 20 percent growth for the S&P 500.
- The Chinese stock market is signalling a slowdown in that country. The small-cap and tech heavy Shenzhen Exchange is in bear market territory, down 23 percent from its recent highs, and the larger-cap Shanghai Exchange is also down 22 percent. "Chinese stocks have priced in a full escalation of a trade war," Brendan Ahern told me. He runs the Kraneshares suite of ETFs that invest in the mainland China market.
All this leaves investors confused as we enter the second half of the year. "The question is, where are we?," Alec Young, Managing Director for Global Markets Research at FTSE Russell told me. "Is it a weak bull market? Are we just in a trading range? Are we dead money?"
Young acknowledges that there is still plenty of good news:
- Buybacks are at a record and show no signs of slowing down.
- Tax cuts are continuing to provide a tailwind for record U.S. earnings, and U.S. growth is still strong.
But that information was already factored into stocks in the fourth quarter of last year.
Young takes heart that the Atlanta Fed is calling for a 4.7 percent GDP rate for the second quarter, stronger than even projections earlier in the year: "That growth will take some of the sting out of the flat yield curve," he said. "Better economic data should get the 10 year up."
But Young admits the waters are muddier now: "You're not making a lot of money as a buy and hold, and the path is not as clear as it was early in the year."