A Look Ahead For The Markets For The Second Half Of 2018

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Logically, the calendar should have no effect on the stock market. Seasonal swings in sales of companies are known in advance and built into stocks during the year for example, but the human tendency to divide things up into segments lends a significance to the end of months, quarters, half-years and years. That is when bonuses are calculated and traders, investors, fund managers and everybody involved in markets tend to look back at what has occurred and devise strategy for what's next.

That kind of big-picture thinking is important for retail investors as well: it helps to give clarity in a chaotic market such as we have seen recently and enables a focused approach for the next period.

So, with that in mind, what can we expect for the second half of 2018?

The first half of the year doesn’t give us many clues. The S&P 500, as shown in the below chart, started the year surging, then took a deep dive before entering a period of recovery, but still with a lot of volatility. The net result was a lot of noise, but very little substance. The index closed the half-year on Friday 1.6% above where it closed 2017. The volatility, however, was the result of some very real risks, and those risks are still with us as we head into July.

The most talked about is the risk of a trade war. So talked about, in fact, that it is easy to get bored with the subject and underestimate the potential effects. The fact that the market has recovered even amid tariffs and retaliations suggest that traders believe the whole thing is a bluff and a negotiating tactic on behalf of the President. That view has now become the conventional wisdom and was espoused just this morning by multiple analysts on CNBC’s early programming.

It may be almost ubiquitous, but it is not necessarily correct.

In part, it rests on an arrogance from the market that looks hard to justify. There seems to be a belief that whatever Trump says, the free trade argument is so blindingly obvious that it will win out eventually. After all, these are Republicans, right?

Well yes, but when somebody as committed to free markets in the past as Larry Kudlow comes out in favor of restricted, government-controlled trade, it is a sign of the times. This is not the pre-Trump Republican Party and basing decisions on the assumption that they will oppose their leader and stick to their free market roots looks like wishful thinking based on what we have seen so far.

Contrary to the President’s tweets, history shows us that there are rarely, if ever, any winners in trade wars. They tend to escalate to the point where the damage done forces some kind of a deal. The personality of the current President and the words of the other parties involved make that the most likely outcome this time as well, and even if the market remains in denial, that will dampen any enthusiasm.

The potential economic damage of a trade war, or rather multiple concurrent trade wars, would pose a risk at any time, but now, as the Fed and other global central banks start to tighten monetary policy, the policy looks particularly dangerous. There is, however, one ray of hope, and it is a strong one: The U.S. economy, like most capitalist economies, is adaptable, and therefore remarkably resilient. It tends to do well despite the best efforts of politicians and has been on a sustained, if slow, path to recovery since 2009.

Consumer confidence and spending is, after an understandable period of skepticism, finally starting to respond to that recovery. That spending sparked a rally in the moribund retail sector in the first half of the year as well as pushing more generalized corporate profits to record highs. With that backdrop, even something as damaging as a trade war can be looked at as a temporary thing.

That will probably limit the market reaction over the next few months but will cap potential gains. So, as unsexy a call as it is, the most likely path for stocks over the next six months is a continuation of the last six. Investors can expect volatility as news breaks, but the underlying economic strength suggests a series of recoveries between those news-driven shocks.

While confidence remains high, stay calm and ride out the volatility, but at some point, the damage done by tariffs will become clear and at that point you can expect a major correction. The resilience of the U.S. economy will be tested, but will ultimately win out. If you have some cash available, buy on those dips.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

This article appears in: Investing , Investing Ideas , Economy , Stocks , US Markets

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