To my clients:
It was a down week for North American stock markets with the Canadian TSX falling 0.6%; the U.S. Dow Jones Index falling 0.1%; and the U.S. S&P 500 falling 0.1% .
It is the first week of a new month (and, for that matter, a new year and decade as well). Typically this week would see the usual slew of major economic releases for the preceding month. This time around, owing to the timing of the January 1st holiday, only one of the three indicators I typically track has been released – the ISM Manufacturing Index. To be blunt, at a reading of 47.2, it disappointed. This is the fifth consecutive month that the index has fallen below the 50.0 reading that separates expansion from contraction. 47.2 also marks the lowest reading for this metric since 2009 when the economy was beginning to emerge from the depths of the 2008 financial crisis. Again, I don’t wish to equivocate – the reading disappointed and I had been hopeful that we would start to see recovery in this particular indicator such that I could look to add back some equity to client portfolios. With this reading, I think that decision may have to be deferred another month (the pending two releases deferred until next week - the ISM Non-Manufacturing Index and the monthly U.S. Employment Report - may yet sway me on this front, but both would have to be exceptionally strong in order for me to do so).
The preceding being said, it is important to note that manufacturing: a) now makes up barely more than 10% of the U.S. economy, whereas it once represented nearly 30% post World War II through the 1960’s; b) likely because of “a”, the ISM Manufacturing Index is now a far less reliable indicator of overall U.S. economic activity than it once was, and it has often fallen below the 50.0 threshold through this now 11-year old expansion (it fell below 50.0 in 2012, 2013, 2015, 2016, and now through the end of 2019) without derailing the overall economic expansion; and c) likely owing to both “a” and “b”, absent sympathetic deterioration in the much larger “services” sector, it is felt that manufacturing must now suffer a sustained drop below an ISM reading of 45.0 to be a harbinger of imminent recession. Still, the reading in subsequent months demands attention.
Yet, if one thinks about it, is it really surprising that the Manufacturing sector has weakened since the summer? As all know, the U.S. has been embroiled in a trade war with China for well over a year, and the steepening tariffs and counter-tariffs by both countries were surely taking a toll. Yet as all will also know, there was a Phase 1 trade agreement reached earlier in December, and it has recently been announced that the signing ceremony will take place in Washington on January 15th. Included in the Phase 1 deal are a rollback of some existing tariffs, and one would presume that the reduced tariffs will be stimulative for manufacturing production…. unless, of course, too much damage has already been done and the “Rubicon” has already been crossed in terms of sentiment, and the related self-fulfilling prophecy that “fear” of recession can itself lead to recession. I don’t believe this is the case, and I think the strength in Services and Employment (not to mention still strong sentiment indicators) likewise argue that this isn’t the case. But, it is a definite possibility, so it would be unwise to be overly rash with portfolio positioning just yet.
In my last update prior to the Christmas holiday, I had suggested that this week’s update would be devoted to the U.S. election. Frankly, I changed my mind. I don’t think the topic of election warrants a full write-up. Instead, I can summarize my election thoughts for 2020 as follows:
- Ignore the Roar: media headlines will begin building throughout the year, and it will often seem as though various turning points in the plot will have a market moving impact. To not be totally dismissive to the concern, this is likely to be regularly true on a daily basis, and on a weekly basis from time to time as well. There is even an outside chance that Presidential election concerns (or equally, hopes) could prove market moving for a period measured in months. However, far more germane to the markets are the underlying economic trends and corporate profit fundamentals which are vastly more crucial drivers of equities than who is in the White House.
- My only exception to the above observation would be if either of the two far-left Democratic candidates (Bernie Sanders and Elizabeth Warren) win their party nomination and then look to be in position to win the election itself. The platforms of both these candidates are a great enough shift from the centrist policies of previous administrations that I do, in fact, think markets would price in the effects of such policies. “Pricing in the effects” is my polite way of suggesting markets would likely decline in the face of a credible expectation that either could win. For a variety of reasons, I don’t think a credible expectation exists. BUT, if it does become a credible possibility, much like I didn’t ask questions when the yield curve first inverted and simply reduced equity exposure in response, I’d almost assuredly do the same were Sanders or Warren appearing likely to win the presidency. In fact, the defensive measures I’d take in such a case would be more substantial than with the inverted yield curve.
- Since Hubert Hoover’s Presidency began in 1929, it is statistically true that markets have performed better during Democratic administrations than during Republican administrations. Excepting my comments about Sanders and/or Warren, I point this out mostly as a matter of interest. Truth be known, I think market performance from one administration to the next is only minimally to modestly impacted by the policies of each (obviously there are shades of grey here) , while impacted much more directly by the prevailing economic cycle and, frankly, the policies of the U.S. Federal Reserve.
Lastly for this week, there has been a material development in the Mideast with the U.S. killing of the Iranian Major General Qassem Soleimani. General Soleimani is oft viewed as the architect of Iranian military policy and destabilization campaigns throughout the Middle East, and certainly would have been in the crosshairs of U.S. military policy for many years now. However, the fact that Trump has authorized General Solemaini’s elimination is still a stunning turn of events. As would be expected, Iran has promised a “harsh response”. In recent minutes as I type this week’s update, the U.S. has announced they are sending more troops to the region. I’ll not pretend I have the foggiest notion of how this actually plays out, but I would simply reassert what I always do in similar situations: while the situation bears watching, rarely do geopolitical events such as this have any lasting impact upon the markets… they simply pass when they pass, and often much sooner than otherwise informed observers would anticipate. At this very early juncture, I’d encourage clients to not fret about the market impact of this development.
That said, and as a lengthy aside, I must say that we are very fortunate to have Helima Croft as the Global Head of Commodity Strategy at our RBC Capital Markets division. I had the opportunity to meet Helima a handful of years ago at the annual dinner of the CFA Vancouver Society. Based out of New York, she is extremely well spoken, knowledgeable, and credentialed. Among many other accomplishments, she holds a PhD in economic history from Princeton; has served in various leading commodity strategy roles at a number of global investment firms; is a member of the National Petroleum Council which makes recommendations to the U.S. Secretary of Energy; worked as an analyst for the CIA focusing on Energy Security Solutions; and is a regular guest on CNBC. I’ve listened to many of Helima’s internal commodity strategy and global security calls here at RBC. Quite frankly she is peerless. I bring this up because her research comments in the past 24 hours were startling in their prescience. Written presumably mere hours before the U.S. attack on General Soleimani last evening, but which I read only this morning after the attack had become news, her analysis of the unfolding situation was eerie in its accuracy. Over the years, Helima had been regularly highlighting General Soleimani’s importance in Mideast affairs, and to my perception became even more vociferous in the wake of the Saudi refinery attacks last September. Likewise, she has long highlighted the strategic importance of Iraq as a proxy battleground between the U.S. and Iran. The sub-title of this morning’s report – again, written before the attack on Soleimani – was “we continue (emphasis Nick's) to see Iraq as the potential tripwire for a direct clash between Washington and Tehran in 2020”. Further, speaking to Trump’s hesitancy to get dragged into armed conflict in the Middle East, she suggested that the killing of American personnel earlier in the week represented “something of a redline for the Trump administration” and that in spite of the subsequent U.S. air attacks, “we do not believe this will be a one and done situation”. I could go on, but the point is it was fascinating and resonating reading, particularly in light of my past familiarity with Helima’s research and policy perspective on the Middle East. I’ll be paying particularly close attention to her comments over the coming weeks as this crisis further evolves.
That’s it for this week. All the best, and Happy New Year!
Nick Scholte, CIM, FCSI
Vice-President & Portfolio Manager
Scholte Wealth Management
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