A couple of weeks ago I was camping in Tahoe with my family and discovered that my trailer’s power system was unexpectantly low. I knew the solution; I simply put the generator on and plugged in. The only problem was that the batteries didn’t begin charging. That is not a good sign and I immediately began thinking of how my wife might respond to me telling her that her water pump wouldn’t be working if we lost power, meaning that she would have to use the <gasp> public restrooms!
Thankfully we discovered the problem before the unthinkable happened (restrooms are apparently a big deal to my wife). The main power system had been shut off by our storage facility when the conducted an appliance test on my trailer before I picked it up. Merely switching the breakers to “on” was like magic!
Tax cuts were supposed to be the generator and charge up our economy like nothing else! Like the generator, they are on, but “trade war” fear has kept the market from charging forward. Geopolitical risks can make the VIX, or “fear index” as it is sometimes referred to, spike. The bigger the spike the worse the stock market response. The last two big spikes (VIX going above 28.5) have preceded market corrections. Since we are not yet reaching new market highs, we cannot say how much the maximum market drawdown will be from this latest correction.
If the worst is behind us for 2018, it will prove to be less severe than the one that happened in late 2015/early 2016. Here is a chart of the last 3.5 years that shows spikes in the VIX versus the S&P 500. Historically speaking, these are not as severe as what was experienced in the past. It is a small consolation while we are in the middle of it.
Unlike finding that a simple breaker was switched off, predicting market behavior is nowhere near as simple. Therefore, it is important to take steps back and evaluate. It is too early to declare if the trade war is just another fear-rising statistic that will soon be forgotten. However, guessing what may or may not happen in geopolitics is not something easily modeled in markets.
We watch impact and signs that pressure is mounting which could result in unfavorable trends. So far, realization of those has not yet become conclusive. We see some evidence that it is raising the risk of global recession, but it is nowhere near a point that we would say that the global economy is at high risk of a recession yet.
It is possible that all of these factors could conspire to ultimately challenge market growth in the second half of 2018, but we need to see more trend evidence that things are breaking down. Conversely, it is possible that solutions are reached and corporate earnings and tax cuts will drive the markets higher. The second half of 2018 looks to hinge on geopolitics, mid-term elections and economics. One of the biggest themes has become global trade versus the fears of too much inflation.
Hopefully this market ends up like my camping trip: a success. If the economic “power” can be sustained (tax relief, strong corporate earnings and just the right amount of interest rate adjustment), batteries recharged (investors regain confidence), and the bad news stops, we can look forward to a more typical second half of a mid-term election year and markets.
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