Last week’s rally in US stocks may just be the effect of a light volume/holiday week melt up, but the numbers were impressive and set the posts for last week’s action:

  • S&P 500 +1.52% last 5 days
  • Tech sector in S&P: +2.29%
  • Russell 2000: +3.10%
  • S&P Small Cap: +3.31%
  • All of which roundly beat “Rest of world” equities, up only 0.70% (MSCI All Country Ex-US)

Although Friday’s Goldilocks-style Jobs Report played a role, this strong performance stands in notable contradiction to market concerns over global trade disputes. Given these have been brewing for months, they should now be bitter enough to make for a less appetizing US stock market. The tape respectfully disagrees.

All of which got us to thinking: what is the bear case for US stocks missing with respect to trade wars? A few thoughts:

#1. Investor uncertainty is keeping a lid on long-term Treasury rates. This helps support US equity valuations and also buffers stock prices from any incremental uncertainty over corporate earnings. Yes, trade wars should be inflationary as the price of imported goods rises. But as with equity price action, the market disagrees with this concern. A few numbers:

  • Current 10-year Treasury Yield: 2.82%. The last time it was over 3% was May 17th. In fact, the benchmark Treasury has only closed +3% 10 days in 2018.
  • 10-Year Treasury breakevens (a measure of expected long run inflation) have been stable at 2.0-2.1% since the start of the year.

#2. Global interest rates are playing a supporting role here. While not enough to help overseas equity markets (All World Ex-US down 4.74% YTD), low yields elsewhere do seem to be putting a cap on US rates. For example:

  • Japanese 10-Year yields at 0.029% are closer to their 2018 lows (0.010%) than their highs (0.092%).
  • German 10-Years yield 0.294%. This is very close to the 2018 lows of 0.278% while the high water mark was 0.764%.
  • UK 10-Years hold to the same pattern. Current yields are 1.268%. The 2018 low close was 1.190%, and the high was 1.645%.

#3. Worries over the economic spillover of trade disputes give investors some hope that the Federal Reserve will slow the pace of rate increases in the back half of 2018. Data from the Fed Funds Futures market December 2018 contracts:

  • While the odds of 2 more increases this year crept up last week, they remain just below 50% (49.3%)
  • The odds of just one more bump in 2018 are still relatively high at 40.4%.

#4. So goes Tech, so goes US large caps, and these companies have less exposure to US trade policy than most sectors. Facebook and Google are banned in China, and Amazon/Netflix have minimal presences. In Europe, the first two do face regulatory threats, but these predate trade war chatter. And Apple, the biggest Tech company of them all, seems naturally hedged by being a large employer in China and a systematically important part of the US equity market.

Bottom line: if Industrials (-4.6% YTD) were the largest weighting in the S&P 500, US market performance would look a lot more like the rest of the world. But Tech holds that spot, and its 26% weighting is enough to support the S&P 500.

Summing up: we aren’t trying to whistle past the graveyard on the tariff topic, but rather frame the discussion in a way that respects market action.There are two sides to every coin. You likely have read enough “Tails, you lose” about the effects of trade wars on equity prices. But so far US stocks are coming up “Heads”, and there are some logical reasons for that.