The Markets This Week

by Connor Darrell CFA, Assistant Vice President – Head of Investments
Fading fears of a global recession helped push risk assets higher while traditional safe-haven assets such as bonds underperformed. U.S. equity indices achieved new all-time highs as several signs of improvement in global economic conditions eased investors’ concerns. Markets cheered marked improvements in both non-manufacturing and manufacturing PMIs, which help to evaluate the confidence of business leaders. There were also encouraging signs from European consumer data, where retail sales rose 3.1% year-over-year. The reassuring data led to an increase in longer term bond yields and a steepening of the yield curve, resulting in negative returns for the major bond indices.

With Q3 earnings season close to wrapping up, FactSet Research is reporting a blended earnings growth rate of -2.4% year-over-year. With revenues rising 3%, the decline in corporate profits helps to underpin the impacts that rising costs have had on businesses coping with the fallout from the U.S./China trade dispute. Despite the decline, the overall numbers have actually exceeded analyst expectations, and many companies have seen their stock prices rise following earnings releases; yet another sign that things may not be quite as bad as many investors may have thought.

The Markets This Week

by Connor Darrell CFA, Assistant Vice President – Head of Investments
Equity markets climbed higher last week, bolstered by healthier than expected corporate earnings and a strong October jobs report which also contained upward revisions to prior data. In addition to the stronger than expected job growth, Friday’s employment summary also revealed a healthy increase in hourly earnings of 3%, which is handily higher than the current rate of inflation and an excellent development for the U.S. consumer. 

The Federal Reserve implemented a widely anticipated quarter point rate cut on Wednesday and bond yields trickled lower as a result, which led to positive returns for bond investors. In his comments following the Fed announcement, Chairman Jerome Powell signaled to markets that the economic fundamentals would need to deteriorate significantly before the Fed would move to cut rates further, and we may now be entering the first period of steady policy rates for quite some time.

First Look at Q3 GDP Yields Positive Signs
According to advance estimates of Q3 US GDP figures released last week, real GDP grew at a rate of 1.9% during the quarter, which was faster than the consensus forecast of 1.6%. Given the Q3 data looks a bit lower than what was observed last quarter, the data provided further confirmation that the U.S. economy is slowing down but is not stalling in a way that many have begun to fear. Consumption growth was once again the primary driver of growth in GDP, with business investment and net exports offsetting some of the contributions from consumption for the second straight quarter, which illuminates some of the impacts of the U.S./China trade dispute. As the U.S. and China continue to inch closer to a “Phase One” trade deal, sentiment surrounding business decisions may have the opportunity to recover, but the length of the economic expansion will be largely driven by the consumer, which continues to benefit from wage growth and a historically healthy labor market.

The Markets This Week

by Connor Darrell CFA, Assistant Vice President – Head of Investments
Stocks continued their positive start to the fourth quarter as markets grappled with a mixed bag of corporate earnings results, additional delays in the Brexit negotiations, and a lack of further developments in the U.S./China trade dispute. The United States and China are reportedly close to a “phase one” agreement which may be signed by next month, but with both sides interested in projecting strength to the rest of the world, it may be another long wait before a “phase two” agreement is reached. International stocks have outperformed U.S. stocks so far in the fourth quarter as optimism surrounding trade has improved.

Interest rates moved slightly higher during the week, with the 10-year Treasury reaching the 1.80% mark. Rates are likely to take center stage this week as the Federal Reserve convenes for its penultimate meeting of 2019. Markets are expecting another rate cut, which would be the third this year.

Cash Not What It Used to Be
With both stock and bond markets generating strong returns in 2019 despite rising economic and geopolitical uncertainty, many investors have grown concerned about future market returns. In a recent poll conducted by Barron’s, the percentage of professional money managers calling themselves “bullish” has decreased to its lowest level in 20 years. As a result of waning optimism, many investors have begun pondering the role of cash in a diversified portfolio, and our general belief is that it still pays to stay invested. The chart below provides a picture of the true return on cash when factoring in inflation. Since the financial crisis, cash yields have been extremely low as a result of aggressive monetary policies, and with the Fed no longer raising rates, it is unlikely that cash yields will be moving higher in the near future. Adjusting for inflation, investors who choose to sit things out in cash are still losing significant purchasing power over time.

The Markets This Week

by Connor Darrell CFA, Assistant Vice President – Head of Investments
Most of last week’s action took place on Friday, when the first signs of meaningful progress toward an eventual trade resolution between the U.S. and China broke into the news cycle. Markets rallied in reaction to the announcement from President Trump that he and Chinese officials arrived at an agreement for China to resume purchases of U.S. agricultural products and to begin addressing issues related to intellectual capital. Ultimately however, many were quick to point out that while the progress is a sign that the two sides are willing to work with one another, this first phase of an agreement is far from a finished product and does not address the most pressing issues that face negotiators; many of which are related to technology, cybersecurity, and intellectual property theft.

The positive sentiment from the trade front pushed a sense of optimism through financial markets and helped to steepen the yield curve, which led to negative returns in the bond market. With the economic calendar dormant this coming week, most of the market’s focus will remain on geopolitical concerns like trade and Brexit negotiations, as well as the beginning of Q3 corporate earnings season, which could provide investors with a better glimpse into how the recent slowdown in manufacturing has impacted corporate profits.

We provide our perspective on many of the above issues in our most recent quarterly commentary, which is available on our website – valleynationalgroup.com/Q32019

Quarterly Commentary – Q3 2019

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Equities:
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.

Bonds:
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.

Outlook:
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

The Markets This Week

by Connor Darrell CFA, Assistant Vice President – Head of Investments
Global equities slid lower last week as investors grappled with continued trade and geopolitical uncertainty, including the announcement by House Speaker Nancy Pelosi of an official impeachment inquiry. Also noteworthy was that shares of fitness equipment manufacturer Peloton fell dramatically on their first day of trading, the latest in a flurry of disappointing initial public offerings (IPOs) this year. Peloton’s disappointing trading debut was further evidence of waning enthusiasm for so called “unicorns” – private companies with valuations in excess of $1 billion, many of which are still relatively immature and not yet profitable.

Despite the ongoing political and trade sagas, the most impactful driving force in markets during recent months has been central bank activity. Both the ECB and the Federal Reserve cut their policy targets during September, and several other banks issued forward guidance that suggested an easing in monetary policy was on the table. Bond yields have moved lower as a result of the shifting tone and continued evidence of softening in the global economy (particularly in manufacturing) and continued that trend last week. In aggregate, the bond market generated modest returns as rates shifted lower.

Politics in both China and the U.S. Creating More Uncertainty
According to comments made by Treasury Secretary Steve Mnuchin during the week, trade talks with China are expected to resume in early October. The two sides will sit down to try and make progress on a trade agreement even as both Presidents face mounting political pressure at home.

For President Trump, the impeachment inquiry will undoubtedly put additional pressure on his relationships with senior advisors and could add an additional layer of complexity to future budget negotiations; in addition to the obvious potential for impacts on his political capital. Ultimately however, with the Republicans still holding a majority in the Senate and a two-thirds vote required to remove the president from office, a transition of power looks highly unlikely. But if the inquiry extends beyond what many seem to believe, the political pressure created by the inquiry might encourage the White House to reach a trade deal sooner rather than later.

For President Xi, the ongoing protests and unrest in Hong Kong represent a difficult situation as well. If Xi is forced to give in to any of Hong Kong’s demands, it could create a perception of weakness and put additional pressure on him to be particularly steadfast in his negotiations with the United States in an attempt to preserve his public image in China. This would likely make a trade deal more difficult to reach.

Ultimately, we continue to advise clients against implementing wholesale portfolio changes in the wake of geopolitical news. While uncertainty often leads to volatility, long-term market performance is driven primarily by economics rather than politics.

The Markets This Week

by Connor Darrell CFA, Assistant Vice President – Head of Investments
There was much for the markets to digest last week, with the Federal Reserve opting to cut interest rates once again by an additional 25 bps. The committee of Fed policymakers were divided in their decision, with two members arguing that no cut was needed and one arguing for a larger cut. Stocks sold off marginally following the decision, but ultimately stabilized and were set to end the week in positive territory before news broke on Friday afternoon that lower-level Chinese officials cut their visit to the U.S. short. Markets interpreted this as a negative sign for the higher-level trade talks scheduled for early October.

In the bond market, yields crept lower as rising geopolitical risks in the Middle East seemed to push investors toward the relative safety of U.S. Treasuries. But with some members of the Federal Reserve policy committee dissenting this past week, markets will likely have less clarity about the future direction of interest rates throughout the remainder of 2019. Given this lack of clarity, investors should expect more interest rate volatility in the months ahead.

The Markets This Week

by Connor Darrell CFA, Assistant Vice President – Head of Investments
Stocks logged their third consecutive week of healthy gains last week, with outperformance rotating toward small caps and value stocks. The shift into value and small cap stocks represented a meaningful change in investor preferences, which have favored large caps and growth stocks for much of the year. Bond investors saw losses as the yield curve steepened and most interest rates moved higher throughout the week. Bond yields were likely supported by stronger than expected retail sales and inflation data.

As far as economic data goes, there continues to be a disparity between measures of businesses and measures of consumers. Consumer data has remained strong as a result of low unemployment, rising wages, and relatively low inflation. However, trade uncertainties have made global businesses apprehensive to invest heavily in new projects, leading to weakening manufacturing activity and lower capital expenditures. In the absence of a trade deal, the U.S. consumer will likely continue to bear the responsibility of keeping economic momentum intact. However, an eventual deal remains our base-case scenario. In the meantime, we continue to advise against attempting to trade around short-term moves driven by speculation surrounding a trade deal. Investors would be well-served by remaining disciplined and diversified in an increasingly uncertain environment.

Oil Markets Disrupted by Attacks in Saudi Arabia
Over the weekend, attacks on Saudi oil assets caused major disruptions to facilities that produce almost six million barrels of oil per day; approximately 5% of the world’s daily oil output. Oil prices have moved higher as a result of the attacks, and U.S. officials have made it clear that they believe Iran to be at fault and that military action remains on the table. Putting aside the concern these types of headlines may instill in us as global citizens, there are a few important things to note from an investment perspective.

First, there is the obvious impact of higher oil prices. Generally speaking, higher oil prices lead to higher costs for everyday consumers. The good news is that global oil production is in a much different place than it was even five or 10 years ago, and the United States now has the ability to make up for shortfalls in global supply.  As a result, it is unlikely that oil prices will be able to spike to levels that might lead economists to worry about their impact on economic activity. For perspective, West Texas Intermediate Crude prices were climbing into the low $60s per barrel as of Monday morning, far lower than the $100+ levels observed as recently as 2014.

Secondly, higher oil prices will likely provide some support for U.S. energy stocks, which have struggled year to date. Energy sector earnings have been lackluster since the precipitous drop in oil prices observed in 2015, and that has made it difficult for many energy companies to meet their profit and revenue targets. The extent to which the U.S. energy sector benefits will likely be a product of how long it takes Saudi Arabia to restore its production back to previous levels, but in the meantime, the United States’ recent investments in energy independence are likely to bear fruit.

In general, oil remains one of the most important basic resources for economic production, but the significance of events like this have declined over the past decade or so as a result of changes to the global supply network as well as advances in technology that have reduced the word’s dependence on oil. These types of events certainly require monitoring, but rarely require a change in portfolio strategy for the average investor.

The Markets This Week

by Connor Darrell CFA, Assistant Vice President – Head of Investments
Markets pushed higher last week despite a weaker than expected August jobs report which revealed a slowdown in hiring but an acceleration in wage growth. Combined, these two trends would suggest that fewer people were put to work during the month, but those that were received higher wages. Manufacturing data also released during the week suggested that U.S. manufacturing activity dropped into contraction for the first time in seven years, likely as a result of the ongoing uncertainty being created by the U.S.-China trade war. Manufacturing activity around the globe has been negatively impacted by trade policy, and it seemed only a matter of time before the U.S. manufacturing sector began to feel those same effects. None of the above news came as a major surprise to investors however, and markets were not significantly impacted. Instead, the confirmation from Chinese negotiators that the U.S. and China were scheduled to hold “serious” talks during October seemed to support investor optimism.

Divergence in the “Soft” Data
Economists often classify economic data into two different categories. Hard data refers to real numbers that are directly measurable, such as GDP growth. Soft data refers to measurements that are derived from survey data, such as consumer confidence. Lately, economists have observed a divergence in the soft data coming from businesses and consumers. For businesses, confidence has been declining as a result of the weakening global growth rates and the uncertainty over the impacts of disruptions to global trade. However, consumers have remained rather optimistic as a result of low unemployment, rising wage growth, and low inflation. Economic demand in the U.S. is driven by both businesses and consumers, but consumers make up a larger component (about 70%). As such, the consumer is in a better position to support the economy moving forward, and the resiliency of consumer confidence remains a key factor in keeping the economic expansion intact.

The Markets This Week

by Connor Darrell CFA, Assistant Vice President – Head of Investments
Equity markets broke a four-week streak of losses last week, pushed higher by a cooling of trade rhetoric coming out of both the U.S. and China. Both sides confirmed that trade talks remain scheduled for September, and comments from the Chinese Ministry of Commerce suggested that China would not immediately retaliate against the most recent U.S. tariff increase. Bonds generated another week of positive returns as interest rates continued to slide lower. Bond yields have been trending downward for the entirety of 2019 as a result of softening global economic data and negative yielding rates in much of the developed world. The lack of positive yield available overseas has created a surplus of demand for U.S. treasuries and led to a significant increase in prices. 

Despite some of the “warning” signals that have flashed in the bond market over the past several weeks, there remains reason for investors to be cautiously optimistic. The U.S. consumer remains very healthy at this point in time and looks poised to continue carrying the economy forward. Additionally, second quarter corporate earnings came in stronger than expected, with corporate margins holding up particularly well despite the wage pressures created by a tight labor market. All of this bodes well for the resiliency of the U.S. economy, and we continue to recommend that investors remain disciplined in the wake of increased volatility.