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The Brave Report: Market Commentary for May 2018

Click here for the PDF version of this report: The Brave Report-May 2018

Note: We have decided to adjust the release date for The Brave Report.  Previously, we released it around the 20th of the month but have decided to now release it in the first week of the month to more accurately cover an entire calendar month rather than half of two.  This will provide an easier to follow tracking of performance and market events during the time frame.

Sell in May and go…… oops. The popular adage of “Sell in May and go away” doesn’t seem to have held true so far this year. Even with the continued uncertainty around trade policy and an escalation of risks coming out of Italy and the Eurozone, earnings results seemed to have carried the month and continued to push markets higher. With very positive earnings in play, these uncertainties could only do so much to contain the bulls and in the end, earnings performance did more than justify recent stock performance.

Along with strong earnings, it seems we are starting to become desensitized to the daily trickle of trade-related rumors coming out of the white house and abroad. When tensions with China moved to the forefront of debate it seems the markets moved on every word or tweet. Now, with other real data to digest, the news is no longer being sold at the rate it was just a few months ago and any recovery is happening much more quickly.  I don’t see any quick end to the many trade negotiations we have going on but until there is more concrete implementation of tariffs everything else is just short-term noise for day traders to sort through.

Market Overview            

During the month of May, all of the major indexes rallied higher.  As has been common, the NASDAQ again was the big winner logging more than a 6% return for the month with the DOW Industrials and S&P500 registering respectable gains of 3% and 2.6%.  The large tech names again led the charge for all three major indexes.  This exceptional performance happened with many clouds of uncertainty hanging over the markets.  If this uncertainty can be lifted at all it will be interesting to see what kind of performance is possible for the remainder of the year.

On the fixed income side, we saw quite a bit of movement. After running up past the 3% level near the middle of the month, the 10-year treasury saw a sharp pullback to below 2.8% as uncertainty in the Italian bond market triggered a rush to safety near the end of the month.  Fears of contagion, similar to what we saw during the Greek crisis a few years ago seemed to grip the fixed income markets for a few days but I expect this fear to be short-lived.

Trade: The rhetoric and speculation continues on the trade front.  Between China, NAFTA and the Eurozone, trade uncertainty again hung over the markets.  However, to date, most of what we have seen are proposals, threats, and posturing with no real concrete trade decisions. The President continues to take a firm stance and propose more and more tariffs but these are still viewed by most as a negotiating tactic.

China and the US continue to have discussions, each week it seems, sending trade delegates across the Pacific to try to resolve what has become quite the tit-for-tat negotiation.  We have seen a trade truce as well as new tariff proposals.  At times both sides have stated there has been progress while still painting the other side as the aggressor.

For other of our closest allies, including Canada, the exemption to the steel and aluminum tariffs that were implemented a few months ago have now lapsed leading to a ramp-up of politically charged comments from other foreign leaders.  This throws into question the possibility of reaching a new deal on NAFTA and is the first time we have moved past just negotiation tactics to actual implementation.  Whether this implementation is fully carried out or retaliatory tariffs take effect is still to be seen but the outcome of these negotiations will be very important for some sectors.

The good news over the past month is that earnings have overshadowed most of this trade news. Prior to earnings season, there was little other data coming out to help shape the markets so the trade uncertainty was much more in focus.  With earnings season pretty much wound down, we will have to wait and see if trade negotiations again take center stage or if another catalyst can help drive the markets.

Italy: We saw a very brief panic moment in the last few days of the month as a political crisis in Italy spilled over to the bond markets. This political turmoil resulted in the appointment of a new prime minister and a sharp spike in Italian bond yields.  Global markets all reacted accordingly, selling off sharply on the news, only to recover just a day or two later.  I bring this up, not because I think it will have any lasting impact on the markets but as an example of the type of market we find ourselves in these days. While we are starting to be a little desensitized to trade news, the markets are still in a sell the news and figure it out later stance. There are few things fueling this mentality. First, this bull market has been charging forward for almost ten years now and a lot of investors that have done so well are worried about losing it. They are worried that we are nearing a top and don’t want to be around when the market finally reverses.

More importantly, the news cycle we are currently in helps to fuel these panic moments.  We are so quick to jump on any potentially negative headline and react to it rather than take a few moments to fully understand what is going on. News sources are also in a rush to get a story out since panic brings clicks so they fail to fully and fairly report on a given situation. This lack of context forces rash decisions. To add even more fuel to this, the market can move so fast these days with the presence of algorithmic traders that if you are slow to react it may be too late.

The good news for most long-term investors is this can present an opportunity. In these sell the news events it is important to take a step back and decide if this is something that can have a lasting impact on economic performance or is it just a sensationalized headline.  If it is the latter, these sharp pullbacks can be a great opportunity to buy quality companies at a discounted price.

Strategy Commentary

I maintained my equity stance from last month. While I am not 100% equity I still maintain my optimism and general overweight to equities.  If some of the trade uncertainty can be sorted out I will quickly add back to my equity positions. Earnings season was very strong and if it weren’t for the trade overhang I think the markets could see a very strong summer r

ally. They have held up well, all things considered, and I see no reason why this quarter can’t be another strong one.

Domestically, I maintained all of my previous positions.  I continue to be overweight technology and it seems to be the gift that keeps on giving.  Going forward, the prospects for growth in this sector far exceeds what I see in most other sectors. I am still maintaining my exposure to financials and consumer discretionary and will look to add more if some risks subside.

Internationally, I adjusted my allocation slightly, reducing my emerging markets exposure and added to my Japanese position. The trade uncertainty with China has added a bit too much risk to emerging markets exposure.  If a deal can be reached I will probably look to add back to emerging markets. I am still staying away from Europe.  The turmoil in Italy is just another example of the potential risks that are present there.

While there was a brief rush to safety this past month, I still have a negative outlook on the fixed income space. I expect rates to continue to rise across the board and this will put pressure on fixed income prices.  I have increased my cash allocation as a replacement.