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‘Risk On’ trades take the lead in October

‘Risk On’ trades take the lead in October

Key Takeaways

  • U.S. growth stocks and emerging markets jump-started the 4th quarter with returns of 2.82% and 4.22% respectively as investors shifted away from ‘risk off’ assets such as defensive stocks and U.S. Treasury bonds
  • The FOMC dropped its federal funds interest rate target for the 3rd time in 2019 to 1.5% – 1.75%. Chairman Powell indicated this cut was the last of the ‘midcycle adjustments’, causing investors to speculate about a pause in rate changes for the next few FOMC meetings.
  • The U.S. and China made progress toward a trade resolution, though the pace and magnitude of the agreement is unclear. Global economies seem to be successfully navigating geopolitical tensions in Hong Kong, unrest in Chile, water wars in Egypt, and the never-ending Brexit saga, among others.
  • Conclusion: Barring a major geopolitical misstep, the U.S. stock market could end the year with a return in the top 25% since 1998. U.S. bonds may end with their best return since 2010.

Global stocks begin to close the gap with the U.S.

The 4th quarter is off to a great start! Despite a sharp decline the first few days of the month, global stock markets were very strong in October. Emerging Markets equity beat the S&P 500 for the second month in a row, up 4.22% versus 2.17%[1]. In typical ‘risk on’, ‘risk off’ fashion, bonds and gold lagged the field in October. Commodities stayed within sight of the leaders at +1.24% for the month, but U.S. and Emerging Markets bonds were far behind at +0.41% and +0.30%, respectively. For the year-to-date, Europe, Australasia, and Far East (EAFE) is picking up the pace with a return of 20.05% versus 23.16% for the S&P 500. The year-to-date leader as of October 31st is U.S. growth stocks at 26.77%.

https://stockcharts.com/h-perf/ui

This strong start to the 4th quarter can be attributed to progress with China/U.S. trade negotiations and no significant negative news about the other international worries facing the markets: Brexit, political uncertainty in the U.S. and overseas, tensions between Hong Kong and China, and soft business confidence around the world. If none of these go terribly wrong, 2019 is on track to be in the top 25% of S&P 500 stock market returns since 1988[2].

Amid this backdrop of relative stability, the Federal Open Market Committee (FOMC) lowered its short-term target interest rate for the third time in 2019 to a range of 1.5% to 1.75%[3]. Fed Chairman Jerome Powell stated that U.S. economic growth is steady despite continued weakness in business investment and exports, and core inflation is running below the Fed’s 2% target. The October rate cut was characterized as the final ‘midcycle adjustment’ to help support the maturing U.S. economic expansion. Chairman Powell indicated the FOMC will continue to monitor economic activity to determine the appropriate level of the federal funds rate going forward. His remarks did not include previous language about the Fed acting “as appropriate to sustain the expansion”, causing market watchers to expect a pause in rate changes going forward.

Source: BNP Paribas Asset Management, Bloomberg as of 11/4/2019

In the days following the rate cut, intermediate and longer-term Treasury yields rose, reversing the yield curve inversion seen for much of 2019 and signaling diminishing investor expectations for a near-term recession.

The return to an upwardly-sloping yield curve is a relief to market watchers. A healthy banking system requires short term rates to be lower than long term rates for banks to maintain consistent profit margins. Higher long-term yields encourage investors to take a longer-term perspective and make more strategic investments. Institutions such as pension plans also have a better chance of satisfying their obligations to future retirees. In general, financial markets do a much better job allocating capital when short-term interest rates are lower than long term rates.

Source: www.treasury.gov

Looking beyond Treasuries, corporate bond yield spreads have drifted back toward the extremely low levels seen in early 2018. This is another indication that investors are comfortable taking risk right now. At Warren Street Wealth Advisors, we’re watching for excessive risk taking which could mean an asset price ‘bubble’ and potentially the end of the stock and bond rally. The occasional drops in market prices we see from time to time are a healthy sign that investors are making rational decisions rather than reckless speculation.

Corporate bond risk premiums drift near historic lows

Let’s not forget the global economy, which the Fed has often mentioned as one reason for reducing interest rates this year. Though the data remains mixed, the International Monetary Fund is forecasting global GDP to close 2019 up 3%, with the U.S. at 1.7% and Emerging and Developing Economies up nearly 4%[4]. The IMF expects global growth to improve in 2020 to 3.4% as Europe adjusts to the new tariff landscape and political uncertainties diminish.

Global GDP projected to remain low but positive

A global recession is highly unlikely through the end of 2020 and probably longer, but there are significant risks to this outlook! The IMF is urging political leaders to defuse trade tensions and reinvigorate multilateral cooperation, rather than focus solely on accommodative monetary policy to keep the world economy afloat.

Bottom line: The U.S. economic expansion remains on track and should end the year well, barring significant missteps in the global economic and political landscape. Though it’s been a bumpy ride, investors are likely to close the books on 2019 with healthy profits from both stocks and bonds, and meaningful progress toward achieving their financial goals.

Marcia Clark, CFA, MBA

Senior Research Analyst, Warren Street Wealth Advisors

 

 

 

DISCLOSURES

Investment Advisor Representative, Warren Street Wealth Advisors, LLC., a Registered Investment Advisor

The information presented here represents opinions and is not meant as personal or actionable advice to any individual, corporation, or other entity. Any investments discussed carry unique risks and should be carefully considered and reviewed by you and your financial professional. Nothing in this document is a solicitation to buy or sell any securities, or an attempt to furnish personal investment advice. Warren Street Wealth Advisors may own securities referenced in this document. Due to the static nature of content, securities held may change over time and current trades may be contrary to outdated publications.

Form ADV available upon request 714-876-6200

Growth stocks take the lead year-to-date

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

[1] Performance represented by ETFs designed to track various market segments: SPY (S&P 500), AGG (Barclay’s Aggregate Bond index), EEM (emerging markets equity), EFA (developed international equity), GLD (gold prices)

[2] Source: www.stockcharts.com

[3] https://www.federalreserve.gov/monetarypolicy/files/monetary20191030a1.pdf

[4] https://www.imf.org/en/Publications/WEO/Issues/2019/10/01/world-economic-outlook-october-2019

August market commentary

In an uncertain market environment, which is better?

The U.S. stock market feasts on recession fears before regaining its risk appetite in late August

Key Takeaways

  • President Trump added, then delayed, another tariff on Chinese goods, exacerbating trade tensions and concerns about the strength of the global economy. As talks with China resume, Britain’s new prime minister attempts to achieve a ‘hard Brexit’, and the Eurozone PMI index falls into contraction territory.
  • The U.S. economic menu included something for everyone: for the pessimist, softer than expected gain in overall jobs with only 130,000 payroll growth in August. For the optimist, the broader measure of civilian employment surged by 590,000. Manufacturing remains a worry as contraction in that sector continues. Despite the generally stable U.S. economy, the Fed cut rates by -0.25% in July and is expected to cut again in September.
  • Conclusion: Tariffs and political uncertainty are depressing an already delicate global appetite for risk. The U.S. is buffered by its large domestic market and expanding trade with alternative suppliers, but isn’t immune to a global slowdown. Lower interest rates may provide a brief energy boost, but won’t develop core strength in business investment. With no political solution in sight, prudent investors should diversify exposure to provide a steady diet of modest returns while avoiding the binge/purge cycle of ‘chasing yield’.

Stocks are near record levels, but investors are uneasy

4Q2019 repeats 4Q2018?

As reported in the Wall Street Journal on September 9, despite a buoyant stock market so far this month, some investors fear the market may repeat the ‘binge and purge’ cycle experienced in 2018.

Looking as far back as 1928, September is historically the worst month of the year.[1] Given that most of the tensions which led to the market tumble last year are still present – trade tensions, global manufacturing slowdown, falling growth of corporate profits, and political uncertainty at home and abroad – concern may be warranted. Combine these headwinds with diminishing marginal returns from accommodative monetary policy, and we might finally be nearing the end of the longest economic expansion in recent memory. Not that we’re calling for a recession! Just that the growth engines of the global economy are beginning to run out of fuel.

[1] https://www.wsj.com/articles/stocks-are-back-near-records-but-memories-of-2018-leave-investors-uneasy-11568021402

Bonds have been a dietary staple during stock market volatility in recent quarters.

Despite the S&P 500 posting a year-to-date return of nearly 20% as of August 31st, bonds have actually outpaced stocks for the trailing 12-months. The severe tumble of the stock market in late 2018 and again in late July/early August gobbled up more losses than the 2019 recovery has been able to replenish. This despite continuing strength in the U.S. economy and corporate earnings generally surprising on the upside of – admittedly cautious – analyst expectations.

The Fed’s rate cut at the end of July sparked an increase in recession fears, though economic data remains modestly positive.

10-year Treasury yield barely above inflation

Decreasing short-term interest rates are unlikely to spark business appetites for borrowing or lending. While 2% short-term rates are great for speculators, they aren’t that much more enticing than 2.25% or 2.50% interest rates for strategic business investments. In fact, 10-year Treasury bond yields dropped so low in September that they provided no more than 0.25% returns above inflation. While marginal borrowers may consume more debt at these rates, long-term investors will need to look beyond the safest assets for a risk/reward balance that preserves purchasing power while promoting healthy growth.

Manufacturing businesses suffer from a restrictive diet of trade tariffs and global uncertainty.

While the U.S. economy overall remains on solid footing, trade-related businesses are hungry.

Housing starts stabilize

Jobless claims remain low

Retail sales rebound

Housing starts are stable, retail sales have rebounded, and initial claims for unemployment are the lowest in more than a decade…

 

 

…but U.S. manufacturers are in desperate need of an economic shot of Red Bull.

Rising global trade tensions in the wake of U.S. tariffs on steel, aluminum, and lumber imports, as well as those targeted specifically at China, are directly impacting manufacturing activity. According to the National Association for Business Economics (NABE)[1], 76% of goods-producing sector panelists and 42% of TUIC (transportation, utilities, information, communications) panelists reported negative net tariff impacts at their companies.

This impact is illustrated by the significant drop in durable goods orders over the past year or so.

Durable goods orders fall sharply

[2] https://nabe.com/NABE/Surveys/Business_Conditions_Surveys/July_2019_Business_Conditions_Survey_Summary.aspx

[Preceding charts source www.macrotrends.net]

Increasing tariffs are not just eating the lunch of U.S. manufacturing companies. Global exporters are suffering greatly from decreased trade around the world. If we look back at the recovery from the Great Recession, emerging economies such as China are credited with helping the developed world get back on its feet. China in particular built roads, airports, and housing developments with abandon, which boosted earnings for global manufacturing companies, particularly steel and machinery.

But the Chinese economy has had its fill of infrastructure spending, reducing its appetite for imported goods going forward. Combined with the trade war between China and the U.S., exporters have lost a major customer. Eurozone manufacturers have already fallen into ‘contraction’ territory (PMI below 50), and the rest of the world isn’t much better.[3] And Fed Chairman Powell, if you’re listening, lower interest rates won’t have any effect on this trend! No matter how low rates go, businesses won’t go back to the buffet table when demand for their products is already satisfied.

[3] https://www.wsj.com/articles/chinas-power-to-boost-global-economy-is-fading-11564738205?mod=article_inline

Slowdown in China depresses global manufacturing

In an uncertain global economic environment with a reactionary U.S. stock market, diversification is even more important.

Barring major disruptions in trade negotiations, a disorderly ‘Brexit’, or increases in geopolitical unrest, the U.S. stock and bond markets could continue on their upward path for the rest of the year.

That being said, the chance of one of these elements going wrong is significant. Investors should continue to make healthy investment decisions to navigate this uncertain period. The best way to do this is to diversify.

Source: www.portfoliovizualizer.com

A balanced menu of stocks, bonds, and alternative asset classes such as natural resources can provide welcome reduction in volatility while still supporting the pursuit of gains suitable for most investors’ appetites. Which isn’t to say even the most well-diversified investors won’t experience some indigestion along the way! But putting your investment eggs in several market baskets can avoid catastrophic losses and help you achieve a healthy balance of risk and return over the long term.

Marcia Clark, CFA, MBA

Senior Research Analyst, Warren Street Wealth Advisors

 

 

 

 

 

 

DISCLOSURES

Investment Advisor Representative, Warren Street Wealth Advisors, LLC., a Registered Investment Advisor

The information presented here represents opinions and is not meant as personal or actionable advice to any individual, corporation, or other entity. Any investments discussed carry unique risks and should be carefully considered and reviewed by you and your financial professional. Nothing in this document is a solicitation to buy or sell any securities, or an attempt to furnish personal investment advice. Warren Street Wealth Advisors may own securities referenced in this document. Due to the static nature of content, securities held may change over time and current trades may be contrary to outdated publications.

Form ADV available upon request 714-876-6200