Last week kicked off the start to the fourth quarter of 2019 and it was noted with tremendous volatility, with the Dow Jones at one point falling a cumulative 1200 points from peak to trough. With investors ready to declare this the worst trading week of the year, the index then rallied back strongly to close off the week down only less than a percent. Had investors gone on vacation this week, the end result would have been shrugged off and unnoticed by most.
So what did we learn during this notably volatile week? We witnessed that investors are still anxious about the potential for a recession. The psychological scars from the 20% decline in Q4 2018 are deep. So much so that this year’s May and August drops of 7%, although smaller by comparison, evoked similar feelings of dread. Although stock markets have proved each time to be able to recover and grind towards incremental new highs, investors have become sensitive to any news and data that hints of a slowing economy.
What had got the markets’ attention last week was the ISM Manufacturing data. The reported number missed expectations and technically fell to a level that hinted at an economic “contraction”. Although this has not been the most historically reliable recessionary indicator, it has led to the reemergence of the “R-word” (Recession). Recessionary fears seemed to have gone away for a few weeks, but have reappeared in the investor vernacular again. In regards to the ISM manufacturing number, we see this as confirming what we have all known for some time – the global economy has been weak. Gradually & eventually, it would seep into American industries, and the latest manufacturing numbers are a testament to that. The weak number was likely exacerbated from renewed trade war concerns, which perhaps led manufacturing purchasing managers to be less aggressive with their plans of expansion and capital spending.
It should have been expected that America could not be immune forever to a slowing global economy. However, the important consideration that needs to be made is whether this has impacted America in a broad sense, or just the manufacturing industry. It’s important to note that manufacturing only represents about 15% of the economy. The larger portion, 85%, is from services which were reported to still be in ‘expansionary’ territory (albeit the pace of expansion is slowing). This is not to say that manufacturing has no weight, but it does re-confirm the important idea that so long as the American consumer is healthy, the economy can continue to chug along.
The US consumer, as it relates to their spending and confidence, are important metrics to track since consumers make up 70% of the American GDP. To get a better appreciation of the US consumer, we believe it is important to look at the full picture. US Consumer spending had a blockbuster 5-month growth streak that lasted till July (best since 2005). On a year-over-year basis, consumer spending is still up 1.4% for Q2. Disappointingly, spending rose modestly at 0.1% in August. That being said, at this moment, we would still consider the consumer to be generally healthy. It’s hard to say the consumer is in poor shape when the economy records a 3.5% unemployment rate. This indicates that people have jobs and therefore have money to spend. Additionally, the Consumer Price Index (measuring inflation of goods) was unchanged in August and still undershoots the 2% target of the central bank. This tells investors that despite the headlines of tariffs and trade wars, it has not led to any meaningful or disastrous price increases for consumers and has yet to visibly deter spending. Further to note, personal income rose 0.4%, wages increased 0.6% and savings rose to $1.35 trillion in the month of August. Finally, with interest rates falling, this will lead to less onerous debt and mortgage payments which effectively results in more money in consumers’ pockets. Looking at the full picture, it appears to be too early to be too alarmist regarding the American consumer, though we recognize that consumer data will ebb and flow with trade and political headlines.
The evidence for a protracted fall in consumer confidence and spending is not quite there yet. And yes, we emphasize the word “yet”, as it is something we are tracking. We don’t take consumer confidence for granted, as talks about impeachment (albeit unlikely), an Elizabeth Warren presidency, and fears of unproductive trade talks between China/US can cause data to change.
Ultimately, we endeavor to take the ‘million foot view’ of the investing environment to invest with a steady hand. We submit 10 points for investors to keep in their back pocket.
1. October is traditionally a weak month, however, Q4 as a whole is generally positive
2. Markets are only 3-5% from all-time highs and the year has been strong, so some profit-taking amidst uncertainty is understandable
3. Although volatility is high, markets have traded in this exact range for 18months now. Therefore, the action falls within the “normal band”, and we have yet to see any conviction of a breakout in either direction.
4. Dollar denominated assets are still in favor, leading to more US dollars being purchased globally, which eventually are invested in US assets like equities.
5. Dividend Yields are still extremely favorable relative to long term bond yields. This makes equities the more attractive investment for long term investors.
6. Trump rarely sits on the sidelines for an extended period of time when markets take a dip, and usually comes out with a newsworthy headline to boost investor confidence
7. The Fed is committed to a low and likely lower interest rate environment which at the minimum means they are reducing obstacles to growth
8. The economy is still running at roughly 2.5% growth
9. Little corroborating evidence of a near term recession from the majority of recessionary indicators
10. Corporate earnings impressed last quarter, which has led some analysts to believe Q3 earnings could also be better than expected
From our conversations with clients, we have attempted to prepare them for the expectation of further volatility – and indeed it has been a volatile start to October. We do not know what the next triggering event will be, as the market can unpredictably find any excuse to sell off. In fact we are quite surprised at how resilient the market has been over the last two months given we have experienced a trade war escalation, major oil supply disruption, a divided fed on rate cuts and calls for impeachment. Ultimately, it may just be that the market fundamentals are better than how investors actually feel.