Adviser Outlook, October 2019
- U.S. stocks have returned 20.6% through September and bonds are up 8.5%—it’s been a strong year for investors
- Global economies, including the U.S., are sending mixed signals about slowing growth and the potential for recession
- Whether it’s the U.S.-China trade war, Brexit, geopolitics in the Middle East and Hong Kong, a U.S. impeachment inquiry or a vitriolic election year ahead, our clients’ portfolios are designed to withstand market volatility
U.S. stock markets closed the third quarter hovering just below all-time highs. Despite the parade of potential market disruptions, stocks and bonds have generated strong gains. The S&P 500 index has returned 20.6% while the broad U.S. bond market was up 8.5% for the year at September’s end.
Given the host of worries investors have faced this year, from the ongoing trade war with China, the Brexit debacle and mass protests in Hong Kong, to conflict in the Middle East and an impeachment inquiry in the U.S., the markets’ returns are simply remarkable. Plus, recession fears resurfaced and receded several times over the last quarter.
So far, we’ve seen little evidence that would lead us to think the strength of the U.S. consumer—the primary driver of our economy and to a significant extent the global economy—is weakening. The job market is robust, with unemployment at a 50-year low, wage growth has been steady, spending continues to rise, savings are within reasonable bounds and household debt is near all-time lows despite the high levels of outstanding student loans.
Nevertheless, based on all the factors noted above, we expect to see the increased volatility we’ve experienced over the first few weeks of October continue through the end of 2019 and well into 2020.
Third Quarter Review
- U.S. bonds outpaced stocks in the third quarter and over the last 12 months
- The U.S. stock market has generated strong gains year to date; developed and emerging foreign markets have gained less ground
- Stocks in higher-yielding sectors benefited from interest-rate policy and recession fears; energy stocks fell on lower oil prices
After hitting record highs in July, U.S. large-cap and broad market indexes pulled back in August, then reversed course and rallied in September. All told, over the three months, the Dow Jones Industrial Average and S&P 500 index returned 1.8% and 1.7%, respectively, while the MSCI U.S. Broad Market index (which includes mid- and small-cap stocks) advanced 1.2%.
As noted above, U.S. stocks have had a good year thus far, with returns running between 17.5% and 20.6%, depending on which index you look at. Yet if we extend our view and include the final quarter of last year, the gains are more modest, as the period includes the sharp December 2018 pullback that brought us nearly to bear-market territory when the S&P 500 declined 19.4% from its peak. Over the 12 months ending in September, the S&P 500 has returned 4.3%, the Dow is up 4.2% and the MSCI Broad Market index has gained 2.9%.
The MSCI EAFE index, a measure of developed foreign market returns, fell 1.1% during the third quarter on indications of slowing economic growth in Europe and questions concerning the outlook for Brexit. The unsettled state of global trade talks also had a disproportionate impact on foreign markets. Despite a 12.8% return so far in 2019, the EAFE index is showing a small 1.3% decline over the last 12 months.
The effects of the ongoing U.S.-China trade war have been felt most strongly in emerging markets. Following the implementation and threat of additional U.S. tariffs, the MSCI Emerging Markets index pulled back 4.2% in Q3. The index has significantly lagged both developed foreign and U.S. stock markets, with a 5.9% gain year-to-date and a 2.0% dip since this time last year.
Traders sought stocks of companies that have traditionally been less sensitive to economic factors during the third quarter. Utilities stocks returned 8.9% over the three months, while real estate investment trusts and consumer staples companies gained 7.7% and 6.0%, respectively. The technology sector has been the best performer year-to-date, with a 30.5% return.
The energy and health care sectors were the laggards in Q3. Energy stocks declined 7.7% on fears that slowing economies will lead to lower demand. (The sector is also the worst performer year-to-date and over the last 12 months.) Meanwhile, health care stocks pulled back 3.2%. The industry has become and will likely remain a key policy issue in the 2020 presidential campaign, giving traders pause and long-term investors like us opportunities at discounted prices. The sector has a modest 6.2% year-to-date return.
As bond yields fell over the quarter (and during the last nine and 12 months), bond prices rose. The Bloomberg Barclays U.S. Aggregate Bond index, a broad measure of the U.S. bond market, gained 2.3% during the third quarter, is up 8.5% this year and has returned 10.3% year-over-year. With market-watchers expecting another Federal Reserve interest-rate cut, this bond market tailwind could continue blowing a little longer—a positive for total-return investors, but a negative for those seeking income from falling yields.
- The impeachment inquiry may generate the most headlines, but the state of corporate earnings, consumer financial health and interest rates will determine the direction of the economy and markets
- U.S.-China trade talks remain a wild card—higher tariffs could push us into a global recession; compromise could delay it
- We’re focusing on any needed adjustments to client portfolios based on our assessment of the evolving relationship between expected risks and returns
Heading into the final quarter of the year, our investment team is feeling cautious. The mixed signals we’re seeing from the economy combined with some of the big, open-ended questions we’ll be facing in the short and intermediate term has tempered our near-term outlook.
On one hand, the manufacturing side of the U.S. economy is slowing. Plus, we think that corporate earnings for the just-ended quarter will roughly match what they were a year ago, with low to no growth over the last 12 months. The partially inverted Treasury-bond yield curve suggests cracks are forming and potentially spreading in our economy. And of course, the risk of an escalating U.S.-China trade war remains an unknown.
We are weighing these concerns against some very real positives, though. U.S. consumers are on solid footing. Unemployment is running just 3.5%, and retail sales have rebounded ahead of what could be a healthy holiday spending period. Recent measures of sentiment show that investors are feeling increasingly bearish, and this is typically a contrarian indicator (meaning we read it as potentially bullish) for the markets. Interest rates are also near historic lows, making it cheaper for consumers and corporations to borrow cash. And inflation has yet to rear its head in any meaningful way.
Whether you give the negatives more weight than the positives, for the moment we don’t believe that any of the above equates to imminent recession, but we’re prepared for a more challenging path to gains and short-lived stock market pullbacks as we head into and through 2020. Our team is carefully monitoring the investment landscape as well as the potential risks and opportunities that lie ahead. As always, our clients’ goals and concerns are at the forefront of our decision-making process.
Remember, we don’t have a crystal ball that allows us to foresee and sidestep adversity. If economists are said to have predicted eight of the last three recessions, market “seers” have an even worse record, having called 10 of the last two bear markets. Rather than try to scry the unknowable, for 25 years we’ve been delivering a disciplined, diversified approach to investing through thick and thin markets. At Adviser Investments, we like to say that we are fortune builders, not fortune tellers.
This material is distributed for informational purposes only. The investment ideas and expressions of opinion may contain certain forward-looking statements and should not be viewed as recommendations, personal investment advice or considered an offer to buy or sell specific securities. Data and statistics contained in this report are obtained from what we believe to be reliable sources; however, their accuracy, completeness or reliability cannot be guaranteed.
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Past performance is not an indication of future returns. The tax information contained herein is general in nature, is provided for informational purposes only, and should not be construed as legal or tax advice. We do not provide legal or tax advice. Always consult an attorney or tax professional regarding your specific legal or tax situation.
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