July's Market Faces Ongoing Geopolitical Issues On Several Fronts

Though it’s unclear how the U.S.-China trade relationship, tension in the Persian Gulf, or earnings season might evolve in July, the market does seem pretty certain about one key metric in the month ahead: Rates could be going down.

That’s what futures prices tell us, anyway. As of late June, CME Group Fed funds futures showed no chance of the Fed standing still in July. They showed a 100% chance of the Fed easing rates by at least 25 basis points, which would erase the hike last December that caused so much anxiety back then.

Some investors expect an even more dramatic move, as CME futures are currently signaling a 43% chance of a 50 basis-point cut. That kind of move would erase the last two rate hikes of 2018, and it would put rates back where they were roughly a year ago. It’s not unprecedented to see a 50-basis-point cut, by the way. The Fed did that as recently as 2008.

Expectations of the Fed moving toward easier policy have really picked up since the June Federal Open Market Committee (FOMC) meeting. The market arguably got what it wanted: Hints at a future rate cut, while at the same time the Fed removed the word “patient” from its statement. It had started talking about being patient back in January, but now it’s apparently ready to make a move if needed to help keep the economy growing. However, we will have to wait and see if a rate cut actually happens. 

Stocks rose to new record highs in late June as the Fed got more dovish, but before throwing a party, investors might want to remind themselves that lowering rates—something the Fed seems to be hinting at—is a panacea and could signal that the economy is slowing. Long term, this is not a good sign. Also, it seems like a lot of the Fed’s more dovish signals had already been built into the market during the recent rally.

Earnings and Trade First, Then Fed

We won’t know what the Fed decides until the very last day of July, but there’s plenty to keep investors occupied between now and then. First of all, we have earnings season. Second, there’s the saga of U.S./China trade tensions as both countries begin the month coming out of a fresh meeting between President Trump and President Xi. We also have plenty of data to watch, including a June jobs report that might carry some extra significance considering the surprising employment growth slowdown in May.

The stock market’s recent rally to new record highs could reflect investors’ hopes for a more dovish Fed. However, you could argue that earnings season is where the rubber meets the road.

Potential rate cuts might help jumpstart the ignition, but earnings are what usually drives the market. Unfortunately for anyone who wants the rally to continue, many analysts look for earnings to be light again in Q2. That includes some forecasters who expect overall S&P 500 earnings to fall year-over-year.

One of those forecasters is FactSet. FactSet most recently said it expects S&P 500 earnings to fall 2.6% in Q2, led by a 14% drop in the Materials sector and a 12% drop in Technology. FactSet sees S&P 500 revenue growth of 3.9%, the lowest since a 2.7% bump in Q3 2016.

The earnings growth outlook is a bit skewed if you look at it by sector. The double-digit drops that FactSet forecasts for Materials and Technology weigh a lot on the overall prediction, but FactSet expects six of the 11 S&P 500 sectors to post earnings gains, led by Utilities, Healthcare, and Energy.

Things get started in a big way the week of July 15, with six of the biggest U.S. banks reporting in a three-day span. Investors could be listening to big bank executives for their views of the latest economic developments and where they think things are headed both for the industry and the world outlook as a whole. Their words might get an even closer listen this time around, especially with rates potentially tumbling and divisive issues like Brexit and China trade still dominating the news.

If investors need any more proof that bank executives have expressed concern about the possible ramifications of trade wars, look no further than headlines from mid-June when JPMorgan Chase & Co JPM CEO Jamie Dimon had a meeting with President Trump to discuss trade issues including China and the proposed new deal between the U.S., Canada, and Mexico. It’s not every day that you see a CEO having the direct ear of the president of the United States.

Quick Trade Breakthrough Unlikely, But At Least They’re Talking

Speaking of the president, a lot of the market’s path in July could depend on how Trump’s meeting with Xi turns out at the G-20 meeting at the end of June. A major breakthrough seems unlikely, but some analysts say it might cheer the market if there’s a handshake and the promise of more talks. It would also help to hear that the U.S. plans to postpone any additional tariffs. Those aren’t necessarily the outcomes, of course, but they’re arguably the most positive takeaways to consider hoping for.

Don’t discount the possibility of a negative outcome, either. If the two leaders meet and can’t get on the same page, both countries’ follow-up remarks might put trade talks in a negative light and dampen investor enthusiasm. There’s also the possibility for a repeat of last year’s conference in South America, when a statement came out a week later contradicting everything we heard out of the meeting. With so much riding on this meeting, investors might want to consider caution.

Caution has definitely been the theme over the month heading into July, even as the SPX drove to all-time highs. When you look at the sectors behind a lot of the recent run-up, it’s been the defensive ones like Utilities and Real Estate. Some of the so-called “cyclicals” like Energy, Financials, and Tech did roll up gains in the late part of June, but so did Treasuries. By the time the Fed met, 10-year U.S. Treasury yields were below 2% for the first time since November 2016. When you see yields this low, it’s often a sign that people are buying bonds for their perceived protection.

Volatility also stayed up as July got underway. The Cboe Volatility Index (VIX) remained elevated above 15 despite the stock market’s gains, which is a bit unusual and might mean we could see hair-trigger responses to any kind of news, especially around tariffs and the increasing Persian Gulf tensions.

The hair-trigger responses could start as soon as July 5, when the June jobs report is due. Arguably, this could be one of the most important jobs reports in a while, and it’s one of those that could send the market either spiraling or rocketing. Any market reaction could be more dramatic than usual with so many investors away from their desks for the long weekend, so it might be prudent to take extra care if you’re considering making any trades around that time.

What potentially makes the June jobs number so influential is that it comes after a weak report in May showing just 75,000 jobs created. The Fed came out soon after that and said it sees signs of slowing in the economy, so another weak jobs report for June might reinforce worries that a slowdown is underway. We’ll see.

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