Stocks in correction in May as central banks prepare to cut interest rates

• All stock markets are performing quite poorly in May
• The yield on government securities is significantly improving, which also improves the return on the "Permanent Portfolio"
• Central bankers in both the US and Europe are preparing to cut interest rates

A relatively good month for the markets in April was followed by an almost disastrous May. This is how I would summarize the last two months in global financial markets. In April, we witnessed an upward trend on all the key stock exchanges in the Western world – S&P500 in the US, FTSE in England and even DAX in Germany. In May, this trend turned 180 degrees. In the US, S&P500 fell by about 6% for the month, FTSE by about 3.2% and DAX by about 5%. These corrections do not seem particularly impressive in themselves, but it should be noted that this is the first month since the beginning of the year in which all the major Western markets have undergone corrections. And these are the largest corrections on a monthly basis recorded since December.

Analysts point to Trump's trade war with China as a major factor behind the US market correction. The lack of progress in negotiations in May and the higher likelihood of new tariffs on trade with China have made investors very uncertain about the future of the US corporate sector. In Germany, industrial production continued to decline, and at a faster pace in May, due to the continued weakening of German industrial exports. The combination of these factors in both the US and Europe has actually led to serious concerns about the prospects for global economic growth, especially considering the fact that on the other side of Trump's trade war stands China - the second largest economy in the world.

Meanwhile, the Bulgarian Stock Exchange recorded a slight growth in May and the SOFIX index rose to over 580 points at the end of the month, but the longer-term trend for the first months of 2019 remains eloquently downward. Despite the slight increase in SOFIX, the average yield of universal pension funds was -0.15% for the month, while in April it was 0.78%. On the other hand, the "Permanent Portfolio", whose yield we track in our Virtual Pension Fund, performed significantly better, recording an average yield of 0.59% in May. However, of all the investments we track, Bitcoin performed best. The price of the world's leading cryptocurrency rose by 53.3% in May, which is the highest growth in a single month recorded since the end of 2017. Bitcoin entered a strong bull market in early April, which only began to weaken in early June.

The Permanent Portfolio’s outperformance in May was largely due to higher returns from its government bond holdings. While the S&P500 fell 6%, the Vanguard ETF invested in government bonds with maturities of over 20 years returned nearly 7%. In addition, the price of gold also rose 1.76% in May. The previous month was another illustration of the Permanent Portfolio’s core strength – strong resilience to declines in equity returns.

The latest news from central bankers is... more of the same. Concerns about slowing growth in Europe are becoming increasingly acute for the ECB. These days, the central bank even said that they are ready to cut interest rates directly (something they have not done since 2016) if growth in the Eurozone continues to weaken. And for the moment, it seems that things are going exactly that way. In the first quarter of 2019, GDP growth recovered slightly in key countries such as Germany, but remained quite weak and what is more worrying is that the problems in the German industrial sector continued in the second quarter.

In Italy, the situation is not much better either – GDP growth has recovered but remains anemic and the country’s public finances remain in a very dire state. Moreover, the strong rise of Salvini’s party in the European elections at the end of May most likely means that he will continue to confront the European Commission and the ECB, perhaps even more sharply than before.

Similar developments are taking place overseas. The US Federal Reserve is already considering cutting interest rates, even though growth there is still much higher than in Europe. The problem is that businesses are increasingly worried about Trump's trade wars and that there are already signs that growth is weakening, which are even reflected in the labor market data (which is generally a lagging indicator). Most likely, at the meeting this month, the Fed will officially announce that they are considering cutting interest rates and may provide specifics about the exact circumstances under which they would take such a measure. For the moment, inflation is still around 2%, and it is a key indicator in this regard. The Fed would most likely wait for it to weaken to below 1.5%, in parallel with GDP growth, before cutting interest rates. And there is still time until then.

The trend, however, is clear – expectations of increasingly slower growth, both in Europe and the US, are now widespread. The current business cycle is in its final "slowdown" phase, which is usually followed by a recession.

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