The fact that the stock market remained relatively flat in the first quarter masks the changes going on underneath the indices. Years of NASDAQ leadership represented in large part by the FAANG stocks (Facebook, Apple, Amazon, Netflix and Google [now Alphabet]) eroded in the first quarter. Each of the companies faced increased questions and scrutiny as a result of issues surrounding potential slowing growth, privacy concerns, and potential increased government oversight. This erosion of leadership in the market, the so called “Shooting the Generals” has created an environment where the market is likely to pause until we determine whether the NASDAQ can regain its footing or until another sector or sectors emerge as new leaders.
Earlier in the quarter, it seemed that industrial and small to mid-sized companies focused on domestic growth would emerge as the next group to lead the market higher. However, this confidence buoyed by tax cuts was eroded and the Trump Administration pivoted quickly toward trade and enacted new tariffs on steel and aluminum entering the United States. The Administration created further rancor as they signaled that further actions on trade involving intellectual property and trade agreements, like NAFTA, could be scrapped or amended. While such actions are overdue in the opinion of many, the process will undoubtedly be protracted and sloppy and will create a headwind for stocks in the short term.
In the coming year, new Federal Reserve Chairman Jerome Powell will also be tested. Unlike his immediate predecessors, Ben Bernanke and Janet Yellen, Jerome Powell will be charged with the difficult task of balancing the stated goal of normalizing the raising interest rates while not choking off the economy. Should the new tariff and trade initiatives chill economic activity, the Fed will be forced to reassess whether it can follow through on the three or four rate hikes projected earlier this year.
In the recent stock market turbulence, investors flocked to bonds for safety. Currently, the 10-year US treasury bond yields about 2.75% taxable compared to 2.9% in February after the passing of the tax bill in December 2017. Should the 10-year US treasury bond drift back toward 3%, it will likely demonstrate that investors believe that that the growth can be maintained despite the tumultuous trade environment.
Investors will also be weighing how companies will spend the excess capital associated with the tax cuts enacted earlier this year. After some initial payments focused primarily on improving employee compensation and benefits, most companies have not done much with any of the tax savings. Long awaited mergers and acquisitions in technology and healthcare have been slower than expected. There have been numerous big deals being speculated on or discussed, but few coming to fruition as of yet. Hopefully merger & acquisition activity will improve as the year goes on. Market stabilization would help.
As stocks have struggled in recent weeks, investors in the short term will be affected by the uncertainty created by the Trump Administration, as well as, the strong technical forces as the S&P 500 hovers around the 200 moving average, a key technical support level. If the stock market can successfully bottom near here given the expected boost to earnings from the new tax bill, stocks can resume their uptrend once the impact to earnings can be quantified.
As always, please feel free to call if we may be of service.
Joseph H. Ray