“Dizzy / I’m so dizzy, my head is spinning.” Tommy Roe, singer
Our news and economic cycles appear to be increasingly dominated by the same few policy topics: China and the trade wars, a global slowdown, negative interest rates and the possible impeachment of the U.S. president. While these issues rightly command our attention, investors are seeking some clarity.
As we see below, major equity markets are positive for the year-to-date period through September 30. Earlier gains, rebounding from the 2018 bear market, have held in the U.S.; the issues listed above are partially reflected in the Q3 data, particularly in international stock returns. High-quality bonds have rebounded from last year’s losses as the Fed has revised course and begun gradually lowering rates. Municipal and high-yield bonds have also performed well. Real assets, particularly those related to real estate, have had strong years thus far. Oil shrugged off a recent drone attack on Saudi resources; the dollar is up slightly.
“Although our intellect always longs for clarity and certainty, our nature often finds uncertainty fascinating.” Carl von Clausewitz, soldier and military theorist
Let’s first address the question on every investor’s mind: when will the recession occur? The answer, of course, is that no one knows; the adage runs, “economists have predicted nine of the past five recessions.” The current U.S. expansion recently became the longest post-war expansion on record, but it is also the weakest, as these graphs show:
If and when a recession hits, no one knows how long it will last or how severe it will be. But what we see right now is that the data signals we follow, while showing some deterioration, do not point to immediate recession. We still see job growth, low inflation, positive GDP growth, manufacturing strength (though some weakness is present), low interest rates and a low rate of bond defaults. These are all good signs.
We are cautioned by other data we see, including slowing growth in the index of Leading Economic Indicators, job creation at lower levels than in the previous administration, weakness in exports (as shown in PMI data) and increased wage growth. GDP growth at desired levels is proving elusive despite the extraordinary stimulus from the Tax Cut and Jobs Act of 2017 and unprecedented federal-deficit growth. One interesting note is that despite a declining unemployment rate and a higher GDP-growth trend, the Bureau of Labor Statistics reports that there have been 1.2 million fewer jobs during Trump’s term thus far compared to a similar period at the end of Obama’s second term (6.3 million v. 7.5 million).
“Clarity affords focus.” Thomas Leonard, personal coach
Our concerns around policy clarity lie in three key policy areas:
- Monetary policy: It seems clear that monetary policy is not promoting or achieving desired growth goals. Both here and abroad, the effects seem to be diminishing.
- The global trade war: Despite the stated belief that “trade wars are good, and easy to win,” they are anything but. U.S. consumers and farmers are suffering onerous tariffs and corporations are realigning global supply chains and investment. Most important, negotiation goals, especially for the China-U.S. talks, are unclear. The U.S. trade deficit is growing, not contracting.
- Interest-rate policies: In the U.S., they are uncertain; abroad, they are designed to be stimulative. The U.S. FOMC has reversed its rate-hiking regime and engineered two cuts thus far in 2019. Questions abound regarding the Fed’s long-term goals: stimulate the economy, or control inflation? Fight deflation? Support the slowdown from trade tensions, or continue their original path? These are difficult but important questions that need clarity.
The markets’ demand for clarity is best demonstrated in the graph below. Since the S&P 500 index’s 2018 high last September, equity markets have moved sideways or lower. Quality bonds—the orange line below—have moved steadily higher on recession fears and investor uncertainty.
“For new ideas to be translated into new realities requires not only clarity of vision but also the opportunity to change old realities.” Riane Eisler, cultural historian, author & educator
The other important question for investors is what will happen to stocks. Although stocks have been flat since last year’s high, earnings growth has been positive thus far in 2019. Third-quarter U.S. earnings are not expected to be especially robust and may set negative sentiment for coming quarters. Despite this analysis, we do not see excessive valuations here or abroad. The graph below reflects forward P/E ratio valuations for three key indices as of October 1. A global low-yield environment, coupled with manageable valuations, still indicate a ‘risk on’ environment. We also believe other risk assets, such as high-yield debt, real estate and emerging-markets bonds also have attractive qualities.
As we noted in our recent blog, trying to forecast a recession or time a market decline is impossible. It is highly probable that we will experience a recession in the U.S. in next few years. Generally, markets do not recognize that we’re in a downturn until we begin to emerge from it. We also know that portfolio diversification is important because markets do not all move in lock-step. Other assets in your portfolio, particularly bonds, are there to provide ballast and funds for rebalancing in times of market stress.
We believe the key to weathering a recession is to know where you are in your economic life-cycle and controlling the things you can. Your time until retirement and how dependent you’ll be on your portfolio for funds will influence your exposure to stocks. Investors who have at least five years until they need to draw from their portfolios shouldn’t be too concerned about short-term market declines. The best strategy—and the one we follow—is to keep you on course and look at declines as an opportunity to reposition your portfolio.
As always, please take time to review your financial plan and portfolio(s) and contact us with your comments and questions.
—Your Wealth Management Team at JJ Burns & CompanyDownload Market Commentary
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