It was a bit of a seesaw quarter for equity investors, as the deepening trade conflict with China, concerns over global economic growth, and heightened geopolitical uncertainty all combined to stoke volatility in markets. And as if these issues weren’t enough for investors to grapple with, it was announced in late September that Democrats in the House of Representatives will move forward with impeachment proceedings against President Donald Trump. Yet despite all of the negative headlines, equities still managed to push modestly higher during the quarter, with the YTD return on the S&P 500 rising above 20%. International markets were unable to match the returns in U.S. equities however, with most foreign stock markets sliding lower during the quarter.
Bond markets continued to rally as interest rates moved lower throughout the third quarter. Longer-term interest rates tend to be closely aligned to investors’ collective expectations of future growth and inflation, and both have failed to materialize to the extent needed to sustain higher interest rates. From a growth perspective, the collective global economy has continued to show signs of weakening, and it is possible that some countries in Europe (such as Germany and Italy) may soon find themselves in recession. Inflationary pressures have ticked up recently as a result of the tight U.S. labor market and U.S. tariffs but could also be tamed if the U.S. and China are able to arrive at some kind of trade resolution, which remains our base-case scenario.
Furthermore, trillions of dollars’ worth of foreign bonds now trade with negative yields, a concept that is difficult for even many financial experts to truly come to terms with. Regardless of the reasons behind this phenomenon or even its long-term impacts on borrowers and lenders, it has undoubtedly created a powerful surge in demand for U.S. bonds, which remain one of the best options for yield-starved global investors. With few other places for bond investors to go, the prices on U.S. bonds have continued to be bid upward, pushing yields even lower.
Amazingly, it wasn’t very long ago that some bond market experts were questioning whether the Fed’s balance sheet runoff would lead to a surge in supply that might cause yields to spike meaningfully higher! In our view, the rapid transition from investors fearing rates might surge too quickly to those same investors struggling to find healthy yields at all is a testament to the unpredictability of markets and an argument for maintaining a balanced approach to portfolio management.
The third quarter was filled with uncertainty, much of which will not be resolved for some time. But one thing that was made abundantly clear as the quarter progressed was that in the eyes of the Federal Reserve, sustaining the expansion remains of high importance. In his September press conference, Jerome Powell stopped short of stating that the two recent rate cuts were part of a broader easing cycle, but it is becoming increasingly obvious that the market expects the Fed to keep its foot on the gas with respect to monetary easing. We believe however, that investors should pay more attention to economic fundamentals than to the Federal Reserve, as eventually, the Fed’s influence will wane and all that will be left to drive markets will be traditional factors such as economic growth and earnings. The evidence is mounting that the fundamentals are starting to flash warning signs for investors, but as has been the case throughout much of the past two years, the wild card remains trade. If the U.S. and China can reach a trade agreement, there could be room for measurements like manufacturing activity to rebound and for the expansion to be sustained even longer. In any case, with the strong returns achieved by both stocks and bonds throughout the first three quarters of the year, it is likely an excellent time for investors to rebalance their portfolios back towards long-term targets.
VIDEO: Q3 2019 Market Commentary
Connor Darrell CFA, Head of Investments, shares Valley National Financial Advisors’ summary of the third quarter and its impact on investors and portfolio recommendations. WATCH NOW