After surging to new all-time highs in July, the S&P 500 fell in August on rising recession fears only to recover most of the losses in September. If you are keeping score at home, that marks the fourth time since early 2018 the market has sold off more than 5% after reaching new highs.
Despite the volatility, the market was able to recover enough to eke out a small gain in the third quarter. Through September, the S&P 500 is now up 20.6% year to date. International stocks have not been quite as strong but are still posting returns above their ten-year averages.
Fixed income has been the real story of 2019. Whether bolstered by two Fed rate cuts or investors looking for “safer” investments, bond prices have risen as interest rates keep falling. The Barclays US Aggregate Bond Index, at an 8.5% return YTD, is having its best year since 2002. While investors are quite happy with recent bond returns, today’s high bond prices mean current bond buyers are spending more to get less return in the future.
Market Index Returns as of September 30, 2019
S&P 500 (US Large Cap)
Russell Midcap (US Mid Cap)
Russell 2000 (US Small Cap)
MSCI ACWI X-US IMI Net (Foreign Equity)
MSCI EM (Foreign Emerging)
Barclays Aggregate Bond
Barclays Muni Bond
Past performance is not an indication of future performance.
Recession angst fades
In mid-August, recession talk was everywhere, but a stock market recovery helped ease many of those concerns. It also helped that the news media moved on to a juicier story, the current impeachment inquiry. In terms of recession risks, not much has changed, however. With a strong labor market, consumers continue to support economic growth in the US.
Nevertheless, one area of weakness, in part related to the ongoing trade war, has been manufacturing, both in the US and around the globe. The US purchasing managers’ index (PMI) from the Institute for Supply Management fell to 47.8% in September, the lowest reading since June 2009. Any reading below 50% signals manufacturing output is falling. This is significant but not necessarily a reason to sound the alarm as manufacturing now accounts for less than 12% of US GDP according to the World Bank.
Central banks cut the tension
Citing low inflation, tightening credit, and trade concerns, the Fed lowered the Fed Funds rate twice in the third quarter after raising rates four times in 2018. The fact that the Fed cut rates with unemployment near 50-year lows would have been almost unimaginable a decade ago. Since the financial crisis, the Fed has repeatedly demonstrated a willingness to help keep the economy moving forward and stock prices moving higher—whether by keeping interest rates low, outright purchasing of bonds, or even providing liquidity in the repo market as Phillips discusses in his commentary.
The Fed is not alone. Central banks around the world have been cutting rates this year. The European Central Bank not only cut rates in September but also announced plans to purchase €20 billion in bonds monthly to maintain prices and keep rates low.
Trade weighs on global economy
There is a limit, however, to what the Fed and other central banks can do. Effects of the trade war are showing. China is no longer the top trading partner for the US. Mexico and Canada have both accounted for a greater portion of total trade with the US than China in 2019, as trade with China has fallen 14% versus the first seven months in 2018. With more tariffs planned, this is a trend that is likely to accelerate.
Top US Trading Partners January-July 2019 vs. 2018
Total Trade (Imports + Exports) 2019
Percent of Total Trade 2019
Total Trade (Imports + Exports) 2018
Percent of Total Trade 2018
Source: US Census Bureau
Outside of the US/China rift, developed economies around the world are struggling more than the US. Germany’s manufacturing-led economy is barely above water. German GDP is now expected to grow by 0.5% in 2019 and 1.1% in 2020, down from 0.8% and 1.8% estimates back in April, according to the German Institute for Economic Research.
And while there have been several twists and turns in Great Britain over Brexit, little has changed. Parliament is scrambling to assemble a deal before the current October 31st deadline but it appears, as of this writing at least, that no plan will be reached and the exit date will again be delayed. A delay could open the door for a snap election giving voters a chance to weigh in on how the country should proceed.
Politics vs. economics
Looking ahead, the headline flow is likely only getting started. The current impeachment proceedings in the House of Representatives signals that the 2020 election cycle is in full swing. Politics can evoke some pretty strong emotions, which can be troublesome for investors. While no one wants to think they are biased, this chart from JP Morgan shows most people’s political leanings shade how they view the broader economy.
We continue to say the economy is steady if unspectacular. Economists surveyed by the Wall Street Journal are projecting 2.2% US GDP growth in 2019 and 1.7% in 2020. While one or two disappointing reports aren’t enough to halt the $20 trillion US economy, the stock market tends to shift abruptly based on headlines, as we have seen several times over the past two years.
While we hope the volatility doesn’t continue, we know keeping a long-term focus, or a historical perspective as Frank Bragg puts it, is important. Even a short-term mistake can have long-term implications when investing. So in the face of volatile markets and unexpected events, a steady approach will continue to serve us best going forward.