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August market commentary

September 11, 2019/in Education, General, Investing /by Marcia Clark

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.

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April showers bring May flowers?…or thunderstorms??

June 12, 2019/in Education, Investing /by Marcia Clark

Key Takeaways

The stock market stumbled in May after strong performance in April. The decline was likely due to concerns over the impact of proposed tariffs on Mexican goods, especially given that Chinese trade negotiations are still unresolved.
Treasury yields hit new lows in May as investors fled stock market volatility. However, a 10-year Treasury yield of 2.1% is not sustainable when inflation is hovering around the same level. We expect Treasury rates to increase rather than decrease from here.
Futures contracts indicate an 80% chance of the FOMC decreasing interest rates in July. This expectation is not supported by the economic data nor the plentiful level of liquidity already in the system. Futures investors are inferring more into dovish Fed comments than they should.
Despite pockets of weakness, the U.S. economy is still on track to grow by about 2% in 2019.
Conclusion: Stock market recoveries based on expectations of falling interest rates are vulnerable to ‘headline risk’, but the underlying economic fundamentals remain modestly positive.

When 1st quarter GDP came in at 3.2% many commentators expected an adjustment downward. That revision came in May…to 3.1%

1st quarter GDP adjusted by a scant -0.1%

Despite persistent pessimism about the imminent demise of the U.S. economy, we at Warren Street Wealth stand by our assessment that the economy will continue to grow at a modestly positive pace. Even with the drag on growth from increasing trade tariffs, the International Monetary Fund forecasts U.S. GDP to end 2019 at 2.3%, which is about average for the past few years.

We should be ready for a bumpy ride along the way, however! With global growth clearly slowing – Eurozone GDP is forecast to be only 1.3% this year and China is slowing to about 6.3% – major factors such as oil prices and other commodities are struggling to find a new equilibrium between global supply and demand.

Some market watchers see falling oil prices as a sign of recession, but we believe the energy market will find the proper balance once the long-term impact of current geopolitical tensions is better understood.

Oil prices add to market volatility

Though consumer spending was down in April, spending was strong in March. April’s decline is most likely due to consumers taking a breath after enjoying some extra purchases in March when wages began rising, rather than the beginning of a downward trend.

And don’t overlook the increase in disposal income in April. It isn’t huge, only +0.1%, but to quote one of our clients: “up is up, and up feels good!”

Consumer spending takes a breath after spiking in April

Another area which disappointed investors in May was job growth, which came in much lower than expected at +75,000. The unemployment rate remained steady at 3.6%, however.

Job growth slows, but is still trending higher

So is the economic glass half full or half empty? We’re going with half full. Patient investors who can withstand the market zigging and zagging based on startling headlines or surprising Twitter posts should be OK in the end.

If consumers are still buying and people are still working, where is the real pain in the economy?

Businesses who rely on global trade, either for inputs into their manufacturing process or to sell their finished goods, are feeling the pinch of rising tariffs. Manufacturers who need raw materials such as steel and aluminum are paying higher prices. Farmers growing soy beans and corn can barely make enough money to cover their expenses as the price of labor and farm equipment goes up while demand for their crops goes down.

As reported in the Wall Street Journal, manufacturers in the U.S. and China are still in growth territory with the Purchasing Managers Index slightly above 50, but Europe is clearly struggling.

We’re keeping a close eye on international markets in case weakness there begins to put more pressure on the U.S. economy.

European manufacturing dips into recession

The final factor we’re watching is the level of interest rates.

Without getting into a debate about whether the current inversion of short-term Treasury rates is forecasting a recession or not – see ‘A Few Minutes with Marcia’ video on inverted yield curves – 10-year Treasury rates at around 2.1% are simply not sustainable.

Negative interest rates in other developed countries and instability in our own stock market have led to high demand for ‘safe’ assets. But with Treasury yields barely keeping up with inflation, at some point U.S. investors will be forced to look elsewhere to preserve purchasing power.

When they do, selling pressure will push Treasury prices down and yields up.

2 yr. and 10 yr. Treasury rates hover near inflation

Because of mixed economic data and a slightly inverted yield curve, pessimists are expressing their opinion through Federal Funds futures contracts.

As reported by the Chicago Mercantile Exchange ‘Countdown to FOMC’, as of June 10 over 80% of futures contracts were betting on the Fed decreasing short-term rates when the FOMC meets in July. We don’t agree.

Despite Fed chairman Jerome Powell’s accommodating tone in recent weeks, there is already more than enough liquidity in the financial system to support growth. A decrease in rates would just put upward pressure on inflation, potentially above the Fed’s target rate of 2%.

Fed Funds futures investors bet on falling rates

If we’re correct and the Fed does not decrease rates in July, we may see another dip in the stock market as investors re-calibrate their expectations. For now, just hold tight, watch the data, and wait for spring rains to bring summer sunshine…eventually…