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.

The Markets This Week

by Connor Darrell CFA, Assistant Vice President – Head of Investments
After four days of relative stability in equity markets, President Donald Trump took to Twitter on Friday morning to suggest that U.S. companies should “immediately start looking for an alternative to China.” Markets reacted negatively to the President’s tweet, and the S&P 500 ended the day down more than 2.5%, marking the fourth consecutive week of market declines. Elsewhere, Fed Chairman Jerome Powell spoke at an annual gathering of central bankers in Jackson Hole, Wyoming and discussed the challenge posed to fed policymakers by the uncertainty created by the administration’s strained relationship with China. Powell lamented that there is no playbook that bankers can consult in addressing the impacts of trade uncertainty on the macroeconomic environment.

Stocks Have Remained Resilient in Difficult Environment
The stock market has had a lot thrown at it over the past several months, including a continued escalation in the U.S.-China trade war, a yield curve inversion, Great Britain inching closer to a no deal Brexit, and weakening global economic growth. Yet despite all of this, U.S. stocks have remained very resilient and currently sit just five or so percent off of their all-time highs. Part of this may have to do with the shape of the yield curve and the lack of yield available in long-term bonds. On Friday, the yield on the 10-Year Treasury closed the trading day at 1.52%. Factoring in the current inflation rate of over 2%, a buyer of a 10-Year Treasury is likely locking in a negative real return unless we see a significant and prolonged collapse in the inflation rate over the next 10 years. This leaves investors with less options for long-term return generation, and the logical place to turn is to the stock market.  All of this creates a challenging environment for investors. The risks that seem to be surfacing in the global economy cannot be ignored and suggest a defensive posturing. However, the lack of yield available in global bond markets and the active suppression of interest rates by central bankers has made traditional defensive assets such as cash and fixed income increasingly unattractive. With that said, we continue to believe that the U.S. economy remains strong enough that a recession is not the base case scenario. Much of this is based upon the fact that there is considerable reason to believe that some of the softening in the global economy has been driven by geopolitical issues such as trade friction. The U.S. consumer, (which accounts for more than two thirds of GDP growth) remains very healthy at this point in time, and a reversal in trade policy would likely ease some pressure on economic growth rates. 

The Markets This Week

by Connor Darrell CFA, Assistant Vice President – Head of Investments

It was a volatile week for global equities, as trade tensions, geopolitics, and movements in the yield curve stoked fears of further weakening in the global economy. By far the biggest influence on market returns during the week was the inversion of the 10-year and 2-year treasury rates; which has historically been viewed as a recession warning. The ensuing shift in sentiment pushed equity markets into a selloff and provided further support for a bond market which has rallied strongly over the past 12 months. In fact, last week marked the first time in history that the 30-year U.S. treasury rate dropped below 2%; a sign that investors are questioning whether the economy will be able to return to previously achieved long-term growth rates. 

While it is likely that the future opportunities for investors will be fewer and farther between than in recent history, we remain cautiously optimistic that a trade deal will be achieved and that the confusion and uncertainty the trade tensions have caused will eventually be lifted. The timing of any deal remains entirely uncertain, but it is that uncertainty that makes it all the more important for investors to remain disciplined. We provide our current thinking on the recent volatility, the ongoing trade war, as well as the yield curve inversion in our most recent market note.

The Markets This Week

by Connor Darrell CFA, Assistant Vice President – Head of Investments
Global equities ended the week modestly lower after recouping some of Monday’s sharp losses. A re-escalation of trade tensions dominated the attention of markets for most of the week, as China allowed its currency to decline to its lowest level against the dollar in over a decade. The move has been widely viewed as a response to President Trump’s announcement of a new round of tariffs (a weaker currency makes Chinese goods more affordable for foreign buyers) scheduled to go into effect in September. Bond yields continued their downward trend as the equity market volatility led investors to seek the relative safety of U.S. Treasuries, which still offer attractive yields in comparison to those available in much of the developed world. In many places around the world, bond investors are faced with negative yields.  At present, a record $15 trillion of bonds around the world now carry negative interest rates.

How Do Currency Valuations Affect Investors?
The sudden decline in the value of the Chinese Yuan that followed President Trump’s announcement of a new round of tariffs led many in the administration to label China a “currency manipulator,” a term which was not being used to describe Chinese economic policy for the first time. The rising tensions have increased market volatility and altered the market’s perception of risk, causing safe haven assets such as U.S. Treasuries to rally further.

We often think of our portfolios as being comprised of stocks and bonds, and rarely do we have direct positions in foreign currencies, but it is important for long-term investors to understand how exchange rates fit into the bigger picture.  In general, foreign exchange rates are a byproduct of the economic backdrop. All else equal, a country with a healthier economy, higher interest rates, and a stronger balance sheet will have a more valuable currency. This is why we have seen the dollar continue to appreciate throughout much of the last several years. The flip side of the coin for large multi-national corporations is that a stronger dollar may weaken reported sales and earnings because its products become more expensive to foreign customers. This is part of the reason we have seen a tapering of earnings growth for U.S. companies during recent quarters. 

The strength of the dollar may continue to cause headwinds for large multi-national corporations, but in general, it is a representation of the relative strength of the U.S. economy and should not be overly concerning for investors. The more challenging phenomenon for many investors who may require income generation from their portfolios is that the recent moves have led to increased volatility in markets and have pushed bond yields even lower. In a low-yield environment, it can be tempting for bond investors to seek out more risky assets such as high-yield bonds and the debt of governments located in emerging markets. However, despite their more attractive yields, these investments offer much less protection during market downturns. It will be important for many investors to avoid the temptation to load up on these types of investments and to maintain a healthy allocation to core, high quality bonds due to their ability to provide a counterbalancing effect to equity risks within a diversified global portfolio.

The Markets This Week

by Connor Darrell CFA, Assistant Vice President – Head of Investments
As was widely anticipated by markets, the Federal Reserve opted to reduce its target interest rate by 0.25% last week. However, the dovish pivot was not enough to support equity markets, which ended the week in a downswing following a series of tweets from President Trump which indicated he was moving forward with an additional round of tariffs on Chinese goods. That this announcement came just one day after the Federal Reserve’s interest rate decision is likely no coincidence, as the Fed’s accommodative stance will provide the President with greater confidence that the economy can withstand the consequences of upping the ante with the Chinese.

With the confirmation that interest rates would slide downward and the increase in equity volatility stemming from President Trump’s tariff announcement, the bond market managed a small rally last week. The Barclays Aggregate Bond Index is now in the midst of one of its strongest years since 2011. 

Global Manufacturing in Contraction
Purchasing Managers’ Indices (which utilize survey data to evaluate business confidence and manufacturing activity) released last week revealed that global manufacturing activity remains challenged by the uncertainties posed by the U.S.-China trade dispute and Brexit negotiations. The U.S. PMI remains the only major region that has held above 50 (a critical level which separates expansion and contraction), though it has declined materially over the last several quarters. PMIs in the eurozone, Japan, and China all remained below 50 last month, indicating that these manufacturing markets are in contraction. 

Manufacturing is far more cyclical than top line economic growth, but the reduction in global manufacturing activity that we have observed over the past year is a symptom of the toll that mounting geopolitical uncertainties are having on business decisions. If businesses’ reluctance to invest in production permeates into hiring decisions, it could begin to impact labor markets and accelerate the arrival of the next recession. Given the relative health of the U.S. economy and the potential for these uncertainties to be lifted by a simple handshake between Presidents Trump and Xi, this scenario looks a long way from playing out.  But for investors who have achieved double digit returns in a year where the economic backdrop has continued to weaken, this type of data should not be ignored and may represent a reminder of the prudence of maintaining discipline and avoiding the urge to chase returns during late cycle investing.

The Markets This Week

by Connor Darrell CFA, Assistant Vice President – Head of InvestmentsThe S&P 500 led global equities forward last week as the market’s focus began to turn once again toward monetary policy. In Europe, the ECB indicated that it would reduce short-term interest rates in September in an effort to stimulate the eurozone’s softening economy. Meanwhile, the Federal Reserve is widely expected to take a similar course of action when it meets this week.

Also weighing on global equity returns was mounting uncertainty surrounding the ongoing Brexit saga. Boris Johnson, who has pledged to deliver on 2016’s Brexit referendum with or without a concrete deal in place, won the race to become the next Prime Minister of the United Kingdom.

All Eyes on the Fed
At this week’s meeting, the Federal Reserve is widely expected to cut short-term interest rates by at least 25 bps. However, the bond market has had this expectation baked into current prices for several weeks now, and any market movements are likely to be driven by the forward outlook for monetary policy, which will likely be discussed during the press conference on Thursday. At present, markets are anticipating more than two rate cuts before the end of the year.

Whether or not the market’s expectations for monetary policy are met will be largely contingent upon the strength of economic data between now and the end of the year. Last week, it was reported that the U.S. economy expanded at a rate of 2.1% annualized, which was on the upper range of consensus expectations. That growth was supported by very strong consumer spending, which more than offset a slight decline in business investment. Business investment has remained an area of weakness in recent GDP figures around the world (primarily as a result of uncertainty surrounding trade policy), but the strength of the consumer continues to help keep the U.S. economy on a solid foundation. Furthermore, with face-to-face trade talks resuming between the U.S. and China this week, there is some optimism that progress can be made. Any meaningful progress on trade would likely improve business confidence and could begin to push business investment trends back in a positive direction.

The Markets This Week

by Connor Darrell CFA, Assistant Vice President – Head of Investments
Global equities shed some of their recent gains last week as lukewarm economic and earnings data combined with increasing geopolitical tensions to put some pressure on stocks. Bonds generated positive returns following comments from multiple Federal Reserve policymakers which seemed to lend support for potentially larger rate cuts in the realm of 50 basis points.

There was little to report on from a conference call held last week between U.S. and Chinese trade representatives. The two sides continue to appear far apart on certain key issues. In comments made last week, President Trump stated that there is still a long way to go before a final deal can be reached and left the door open to the possibility of additional tariffs on $325 billion of Chinese exports.

Earnings Update
With 15% of S&P 500 companies having reported Q2 earnings, the blended earnings growth rate is -1.9% on a one-year basis. The relatively weak results so far were largely expected by the analyst community as the initial accounting boost from 2017’s tax reform begins to wane. The good news is that while corporate earnings have been somewhat disappointing on an absolute basis, they have actually largely exceeded consensus estimates. According to data from Factset, the percentage of companies reporting earnings above consensus estimates has been close to 80%; well above the historical average. Often times, market performance is driven by the difference between expectations and reality, and Q2 earnings season has thus far brought an above average level of positive surprises. Furthermore, the beginning of earnings season has seen a large number of companies from the financial services sector report, and many of these companies’ earnings have been hindered by the decline in interest rates that has played out over much of the first half of 2019. 

The Markets This Week

by Connor Darrell CFA, Assistant Vice President – Head of Investments
Most major U.S. equity indices closed out last week at all-time highs, bolstered by seemingly solidified expectations that the Federal Reserve will opt to cut interest rates when it meets in just a couple short weeks. During his semi-annual testimony on Capitol Hill, Fed Chair Jerome Powell noted that uncertainties surrounding global growth and trade continue to cast a shadow over the economic outlook and that inflationary pressures may remain persistently weak. Despite these risks, the general tone of Powell’s comments was still relatively sanguine, supporting our own view that the economy remains relatively healthy, but that increasing weakness abroad could put a cap on the strength of future growth rates.

Setting Expectations
As long-term investors, one of the most important keys to success is discipline. However, maintaining that discipline over the course of a complete market cycle can be very challenging. Volatility can be difficult to bear, especially when the future seems uncertain and our financial well-beings are at stake. That is why we believe one of the best tools an investor can have is a realistic impression of what can be expected from their portfolio. That way, when that next “crisis” inevitably strikes, the element of surprise is diminished, and a decision based on emotion is less likely to be made.

The S&P 500 closed above 3,000 for the first time in history last week. A variety of factors have allowed stocks to climb to all-time highs this year, including expectations for easy monetary policy from the Fed, perceived progress with U.S.-China trade negotiations, and relatively healthy U.S. economic data. But with the U.S. stock market now up close to 20% over the past six months, it is important for investors to set expectations for the future of long-term returns.

For most of us, remaining disciplined requires an understanding of economic fundamentals and valuations, which are the two most important drivers of long-term returns (not Fed policy or trade relations). It is a core tenet of investing that valuations are an efficient predictor of future returns, and that buying stocks when they are cheap has historically been much more successful than buying stocks when they are expensive. Of course, after a strong 20% run over the course of just six months, stocks are more expensive than they were just a short time ago, but the good news for investors is that by most measures of valuation, stocks are still far from “bubble” territory. The current P/E ratio for the overall market stands at about 17x (meaning that investors are paying $17 today for every $1 of future profits), which is much lower than the 25x level that was seen during the tech bubble in the early 2000s. However, compared to the historical average of about 15x, stocks certainly are not cheap either.

As the current economic cycle continues to mature, it will be important for investors to recognize that from current levels, future returns are likely to be a bit lower than they were during the past several years. Luckily, even returns that are meaningfully lower than those achieved during the bulk of this bull market can still be robust enough in a world where inflationary pressures remain muted. With that in mind, if we are able to successfully reset our expectations, we are likely to put ourselves in a much better position to navigate future volatility with better grace and discipline. Often times, staying invested and avoiding the opportunity costs of missed profits can give us a head start on a prosperous retirement.