US equity outlook: trade wars and seasonality battle it out

Now that we have had a third 5% drop for the year, are indices ‘in the clear’ for a strong run into year end?

On average, the S&P 500 suffers three 5% drops in a year. Some years see more than this, and others, such as 2017, barely even see one such move. No one year in the stock market is exactly like any other. But investors and traders need to be prepared, and it helps to know that a market tends to see periodic bouts of volatility, and downside moves, even as it continues to move higher.

S&P 500: a retrospective as we move closer to 2020

2019 has been a textbook year for investors. It began with markets recovering from a sell-off in the fourth quarter (Q4) of 2018. From January until May the market rallied strongly, and then a swift correction took place. This was followed up by a rally in June and July, which was itself followed by a pullback into August.

For the S&P 500, which is the global benchmark index, the ‘best’ months of the year are the October–April period. Historically, the strongest returns occur in this period, while the May–September period is at best one of flat performance for equities. From October equities, on average, rally into the end of the year, and so 2019 may follow this pattern.

The US-China trade war could slow things down

The wildcard here is the US-China trade war. This has the potential to unseat the rally and cause a bigger downturn in equity markets. As investors debate how close the US to recession, we can see that signs of a possible turn higher in unemployment claims and a downturn in new home sales, both signs that a recession is getting closer. A US-China trade war has the potential to spark a US recession, and it is already feeding through to US economic data.

US earnings on the rise for now

US earnings continue to grow, although at a reduced rate, providing a cushion for any downturn. In the long term, earnings drive the stock market, with periodic crises providing the short-term volatility that provides strong buying opportunities. A continued recovery in earnings would be the most positive development for the market, helping to soften the blow of a continued US-China trade war.

In the short term, the outcome of the US-China talks will determine the moves in equities. However, seasonality is now strong for the next six month at least, providing a more positive longer-term outlook. It would be foolish to rule out new record highs for the S&P 500 by year end.