Some Headwinds?

I briefly mentioned in my last post that I think we all need to consider the possibility of some short term headwinds that seem to be mounting in the markets.  I think we need to consider the possibility that over the next few months we are transitioning into a market environment that has the potential to be less friendly for stocks.  I'll outline my thinking below.  

First let's briefly discuss some of the things that are worrying the markets right now. The US economy right now is the envy of the world.  2nd quarter GDP growth could reach nearly 4% according to many economists. However, investors are worried about a slowing worldwide economy and a stronger dollar, generated by rising US interest rates.  Asia, especially China, has seen slower growth as has Europe and emerging market economies. If I am right these will start to sort themselves out later in the year but there is no denying that right now this slowdown has investors concerned.

International trade dislocations are perhaps weighing more heavily on markets than the threat of slowing international economies.  It does not likely help that the Administration's approach to this seems to have little coherence.  What  is announced as policy one day by some member of the President's team is seemingly walked back the next by another official.  Nevertheless it is becoming apparent to markets that the Trump Administration is intent on renegotiating wide swaths of America's trade agreements and is very willing to use the carrot of tariffs imposed on both friends and foes to get what it wants.  Our trading partners are not going to take this lying down and have announced tariffs of their own on goods.  We will see whether this is only bluster as everybody sits down at the table or whether we are on the verge of something more serious.  Clearly though the threat of a trade war has spooked investors.

Here are two other factors that could make for some rough going as summer progresses into the fall.  The first is our often discussed market seasonality.  So far this year stocks have been following our thesis on this rather well.  We saw a rally at the beginning of the year, a sell-off, then a recovery in share prices going into the early summer, followed by a current period of weakness.  If this would hold up closer to the normal pattern we could see one more spike higher before a potential pick-up in volatility.  Of course there is no guarantee this will occur even if we've been close to the pattern most of the year.  It is something to pay attention to as the warmer weather progresses.  August is a dead period for the markets so any additional piece of bad news could have a more heightened negative impact than some might suspect.

The other issue that is likely going to start impacting markets at some point will be the upcoming elections.   Investors have so far not paid much attention to this as November is a long way off right now.  I think there is the potential for the retirement of Justice Kennedy and the President's ability to pick in a very short period of time a 2nd Supreme Court Justice may mean that the elections come into focus earlier than might normally be expected.  Markets could become more volatile if investors perceive a more progressive and less business friendly Congress might be sworn in next January.

As I said last week,  I think investors should take the time and opportunity that a slow period such as this holiday week may afford to go over their portfolios and review their risk profile.  For some a more defensive profile may be warranted. I want to stress that I'm still quite bullish longer term.  I think the US economy is humming along with solid growth.  I think that growth plus the current pace of innovation should provide a foundation for markets at some point absent some unlooked for event. I also think valuations on stocks are fair right now with the exception of certain overheated sectors.  Finally, I also think that currently we are oversold enough so that probability would suggest some sort of short term rally could occur over the next few weeks. Having said that I think the potential for more volatility in the coming weeks and months should not be ignored and for some a more defensive posture might be warranted.