Rising Rates, Trade Tensions and Midterm Elections Outlook
Volatility has reared its ugly head and the S&P500 has lost roughly 10% in recent weeks from its all-time high. Some pundits believe this is the end of our ten-year bull market and this is a result of rising interest rates, a possible trade war and uncertainty about midterm elections. At Varga Investments we believe these fears are overblown and volatility during this time of the election cycle is typical and the bull market will resume onward and upward throughout 2019. Here is why…
Interest rates are still well below historical averages and nominal GDP. Even with one more interest rate hike in 2018 and four more in 2019 the short-term interest rate would be at 3.5%. This would still be below the long-term average interest rate and nominal US GDP growth of 5%. Monetary policy is tightening but remains accommodative. Therefore, we do not think this will seriously threaten the market until after 2019 or possibly even 2020.
China has quietly been cuttings tariffs on thousands of goods. China’s average tariff rate was 9.8% in 2017 and is expected to be down to 7.5% by the end of 2018. So, it appears concessions and compromises are being made behind the scenes. We are hopeful a trade war will be averted, and we believe this will be the outcome.
The mid-term elections add an additional degree of uncertainty to the US stock market. Let’s take a closer look and observe the S&P 500 index returns in the year before and the year after midterm elections and we can observe a distinct pattern. This uncertainty has historically resulted in market corrections in the year leading up to the elections. Dating back to 1962 this resulted in an average -19% return in the year leading up to midterms. The good news is that historically the year after midterm elections has resulted in an average 31% gain.
In 2018, these uncertainties revolve around Democrats gaining control and reversing the Trump administration’s tax cuts and deregulation accompanied by government shutdowns and impeachment rhetoric. We believe, the likely hood of Trump administration policy reversal is minimal as Democrats would have to control both the House and Senate. Republicans are expected to at least retain control of the Senate and the House of Representatives appears to be up for grabs.
Therefore, we believe that interest rates, threat of a trade war and public policy changing direction because of the midterm elections are not a threat at this time. At Varga Investments we believe the stock market will rebound once some of these uncertainties are removed from the picture and the market can resume trading on strong fundamentals. We believe the stock market is currently undervalued and presents a buying opportunity. Clients should consider speaking to their advisors about making prudent IRA, retirement, brokerage account contributions for the year at this time.
Sources: MarketWatch, Strategas Securities, Wells Fargo Investments Institute, First Trust Portfolios LP, Reuters. Past Performance is no guarantee of future returns.
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