Investment Commentary – 3Q 2019

PERFORMANCE

Different quarter, similar story: U.S. stocks and bonds both moved higher in the third quarter. Major stock indices flirted with all-time highs reached earlier in the year, and bonds continued to be fueled by both strong demand amid recession concerns and falling interest rates (which move counter to bond prices).  International stocks did not fare as well, as growth in several key countries tailed off significantly.  However, the U.S. economic expansion continues, due to strong consumer metrics and ever-improving employment numbers.  Recession talk continues to be a popular topic – one which we address in the following sections.

Stocks

Domestic markets shrugged off recession concerns to post solid performance during the third quarter.  Large-sized companies (S&P 500) again outperformed mid-sized (S&P MidCap 400) and small-sized (S&P SmallCap 600).  Overall, U.S. stocks (Russell 3000) gained 1.16% for the three months.

International stocks did not perform as well.  Developed international (MSCI EAFE) lost -1.07% for the quarter while emerging markets (MSCI EM) returned -4.24%. A global manufacturing slowdown has affected many global markets – due in part to a significant reduction in auto sales.

Bonds

Bonds (Barclays U.S. Aggregate) gained 2.27% during the quarter, adding to their remarkable 2019 run. The Federal Reserve reduced short-term interest rates twice during the quarter, providing a strong tailwind for bond prices. Recession concerns continue to generate demand for bonds, as some investors adopted a more defensive allocation.

Alternatives

Positive performance from global real estate (FTSE EPRA/NAREIT Developed) was not enough to overcome the negative influence of natural resources (S&P Global Natural Resources) and commodities (Bloomberg Commodity), resulting in an overall -1.07% loss for alternative assets this quarter.

 


PERSPECTIVE

“I was asked what I thought about the recession. I thought about it and decided not to take part.” – Sam Walton

“They talk about the economy this year. Hey, my hairline is in recession, my waistline is in inflation. Altogether, I’m in a depression.” – Rick Majerus, former University of Utah basketball coach

 

The recession warning signals are:  An inverted yield curve, geopolitical concerns, slowing of corporate earnings growth, and the worldwide manufacturing slowdown.

  • Short-term interest rates have been higher than longer-term interest rates – the definition of an inverted yield curve – at multiple times this year. This condition typically indicates lower long-term growth expectations from markets, and it receives a lot of attention because it has been a fairly reliable indicator of a future recession.  However, the typical time from inversion to onset of recession has ranged from several months to multiple years.  There is one key difference surrounding this inversion: we’ve never had one accompanied by the extensive Federal Reserve involvement in the bond market (i.e. Quantitative Easing) that we’ve experienced in recent years.
  • Both the trade conflict with China and the impending Brexit deadline in the U.K. are creating uncertainty among corporations. While it makes sense that there would eventually be deals worked out in both cases, there is always the chance that tensions will ratchet up further.
  • S. corporate earnings were at record highs in 2018 – that’s the good news. The bad news is that level of growth has proven challenging to sustain in 2019.  While corporate earnings growth is still positive, it has slowed this year as employee wages increase and profit margins decrease.
  • Manufacturing across the globe has seen a downturn over the
    last 18 months, especially affecting the auto industry. Auto production is down significantly from years past, with Germany particularly hit hard.

Some reasons that recession might not be imminent are: consumer strength, central bank policy, lower inflation, and the resilient services portion of the economy.

  • By several measures, U.S. consumers are in great shape. Household disposable income is growing at nearly 5%, while household debt-servicing costs are only 10% of disposable income – the lowest level in more than 40 years.
  • Worldwide monetary policy is easing – which is the opposite from what central banks like the Federal Reserve do before most recessions. Just don’t get me started on the foolish phenomenon of negative interest rates cascading around the world!
  • Inflation in the U.S. continues to be tame – again, the opposite condition from past recessions. The Federal Reserve will not likely feel compelled to raise interest rates as long as inflation doesn’t spike far above their 2% target level.
  • The weakness in manufacturing has not translated into the services sector of the economy. As a percentage of contribution to GDP, services dwarfs manufacturing in the U.S. (roughly 80% to 20%).  If services maintain their strength, fueled by strong consumer income and spending numbers, odds of a recession are lowered.

POSITIONING

Recessions happen in capitalist countries as a natural result of the business cycle.  This long-running U.S. economic expansion will come to an end – we just don’t know when.  Although the next recession may not be as severe as the last one, the memory of 2008 remains fresh for many investors.

We do know:  Market volatility will continue, financial media will continue to use fear and uncertainty to sell advertising, and Planning Alternatives will be here to help you achieve your financial objectives.

To that end, we monitor trends, analyze research, and take action on your accounts – all while serving your best interests as an independent fiduciary.  What steps can you take?  Use this opportunity to re-evaluate the current risk level of your portfolio and to prepare for any significant cash needs over the next twelve months.

Regardless of whether the next recession begins in three weeks or three years, we are honored that you rely on us to be your partner.

Please contact us with questions, or just to chat!

 

Jim Long, CFA®, CFP®, CMFC®
Director of Investments

 

 


Please review Disclosures and Footnotes