May market performance - Rotation from stocks to bonds based on trade war worries

Risk-taking seems like it is ready to be on summer hiatus. Nevertheless, a simple look at the data suggests that the stock to bond rotation seems a little overdone. The difference between stocks and bonds (SPY vs TLT) was over twelve percent, yet the economic data does not suggest a slowdown shock. Investors are reacting to two major themes permeating the global economy. The response to these themes is uncertainty since both issues are still unresolved. 

Trade wars are not going away anytime soon. In fact, positions are solidifying and there does not seem to be any sense of compromise in the air. Tariffs are increasing and widening over more goods. Alternative policies are also being discussed as further war responses, and tariffs are now being used as a tool for foreign policy in the case of Mexico. Costs will increase, margins will tighten, and consumers will retrench. While, in the case of the US, import are still a small part of the economy, these tariff wars extract a toll on consumers, impact capital expenditure plans, and hurt forward earnings for many firms.

The global economy is looking like it will be slower than expected. There may not be an immediate recession, but the concerns from the fourth quarter of 2018 have returned. While housing may be softer, durable good weaker, and retail sales slightly lower, the overall tone in the real economy does not look bad. Conference Board and the University of Michigan surveys both show strong positive views from consumers. The labor market is still very strong, and leading indicators and PMI numbers still suggest positive growth. Signals are more mixed than priced by markets.

This uncertainty is making global macro investing so difficult. There is not much different from 2016 when industrial production was negative but there was a continued strong labor market. Prices reversed after data became more consistent. Bond markets are pricing in two rate cuts in Fed fund futures and the inversion suggests that bonds are more negative than policy-makers. Growth and trade wars will have to get worse for these forecasts to be realized.