3 stock market scenarios

Editor of Market Timing Australia
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The period from November to April is normally upbeat for shares.

Typically, share markets do less well from May to October than November to April as shown by the next chart. Hence the old adage; sell in May and go away until St Ledgers Day (a British horse race).

Source: https://www.ampcapital.com/au/en/insights-hub/articles/2019/may/seasonal-patterns-in-shares-should-we-sell-in-may-and-go-away

The next chart shows how share market returns in the USA, Australia, Asia (excluding Japan), and the World as a whole, differ markedly between the “good” period (end-November to end-May) and the “bad” period  (end-May to end-November). Mind you, even the ‘bad” period on average delivers positive returns but they are a fraction of those of the “good” period.

Source: https://www.ampcapital.com/au/en/insights-hub/articles/2019/may/seasonal-patterns-in-shares-should-we-sell-in-may-and-go-away

That’s not to say it’s all blue sky ahead. According to Lance Roberts, chief investment strategist at Real Investment Advice, the US share market remains extremely overvalued and needs a crash to restore its fair value. In his view, this outcome is inevitable, since America’s corporate earnings have stagnated since 2014 and only share buybacks have kept earnings per share rising since that time.

3 market scenarios

Roberts has charted three courses that the S&P500 share index could take, depending on what path President Trump chooses in his trade war with China.  Since American stocks dominate the global share market, their fate will dictate investor sentiment everywhere.

The first scenario assumes Trump caves into China in October and gets a “small deal” done, which he dresses up as a big victory (just as he did with the NAFTA re-negotiations with Mexico and Canada, which changed little of substance). It would see tariffs removed and give a ‘pop’ to an already overvalued market enabling it to reach a new high by years’ end.  See chart below.

Source: https://realinvestmentadvice.com/technically-speaking-the-risk-to-the-bullish-view-of-trade-deal/

In the second scenario, talks break down and negotiations are postponed to next year. But that would still weigh on corporate profits and consumption at a time when earnings are already declining and the benefits of tax cuts have worn off.  The market would correct as it “repriced” for slower earnings and economic activity. See chart below.

Source: https://realinvestmentadvice.com/technically-speaking-the-risk-to-the-bullish-view-of-trade-deal/

The third scenario sees Trump lose his temper with China and walk out of talks reinstating the tariffs on discretionary goods, and increasing tariffs across the board. In return, the Chinese retaliate by imposing additional tariffs on American goods. An all-out trade war ensues and the market crashes as consumer and investor confidence implodes. See next chart.

Source: https://realinvestmentadvice.com/technically-speaking-the-risk-to-the-bullish-view-of-trade-deal/

The contra view

Robert’s US stock market scenarios all seem plausible but let’s play devil’s advocate to test their robustness. Bloomberg Economics modelling of the tariff moves to date suggests that in two years’ time, GDP in China, the U.S. and the world would be lower by 0.5%, 0.2% and 0.2% respectively, compared with a no-trade-war scenario.  See chart below.

Source: https://www.bloomberg.com/graphics/2019-us-china-trade-war-economic-fallout/

While a 0.2% fall would be unwelcome, it would not be calamitous since the US economy is currently expanding by 3.1%.

Furthermore, every time the economy turns for the worse, central bank and governments embrace stimulus measures that see stock markets boom. Indeed, the perverse new paradigm is that bad economic news is good financial news. This might suggest the more reckless Trump becomes the more monetary and fiscal officials have to prime the pump to keep the show afloat which feeds bond, property and share prices.

What really counts

Historically, political dramas rarely cause major market ructions, unless they translate into interest rate or energy price spike. For example President John Kennedy’s assassination, which shocked the world, dented the US stock index by only 3%, which reversed within two days. Politics is incidental. On the bright side, neither short-term interest rates or oil prices have yet spiked and until they do, history would suggest that a financial crisis (and hence a market meltdown) is not imminent.

Of course, no one can foretell the future, which is why Market Timing Australia lets the share market itself signal when it’s sick and when it’s well. That’s done by tracking its price trend and momentum. When these are positive, it’s safe to be in shares, but when they turn negative it’s best to cash out.

For a free trial subscription to Market Timing Australia visit https://www.markettimingaustralia.com.au/

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regard to your circumstances.

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