Halloween is just around the corner, and markets are giving investors plenty of things to fear. Trade wars, Brexit, inverted yield curve, and now the potential impeachment of a sitting U.S. president, are just a few of the concerns facing the current market. However, no good thriller would be complete without a hero or two. Fighting for the virtuous bulls, we have unemployment holding at record lows (3.7%), accommodative central bank policy around the globe, low inflation and low, but steady, growth in most categories. Couple these factors with strong returns in almost every asset class for the year, and it is easy to have mixed feelings about our current environment. This dichotomy leads us to the main question—will future returns bring us a trick or a treat?
The U.S.-China Trade War Continues…
The main villain is likely the trade war. While the other threats facing the global economy are important, the trade war between the U.S. and China seems to be at the center of most issues. When the two largest economies engage in a trade war of this magnitude, it causes a lot of uncertainty in the global economy. Businesses are more reluctant to expand during times of uncertainty, leading to less spending. Higher tariffs can be another result of this uncertainty, leading to higher overall input costs. Less spending and higher costs create a feedback loop that slows company growth even further. This scenario is what we are seeing in global economies:
- The Eurozone and Japan both just posted their fifth consecutive month of contraction in manufacturing.
- Germany may already be in a recession, posting negative GDP for the second quarter, along with mixed results so far in the third quarter.
- The U.S. has mostly remained strong throughout the turmoil, but given how interconnected the global economic system is, we will not likely hold out indefinitely.
In short, if the trade war continues, it will likely lead to global recession—eventually.
U.S. Economic Fundamentals Are Holding Strong…For Now
So are we bearish on the global economy? No, not quite. As stated before, every good story needs a hero. Our heroes of this story are the strong fundamentals underlying our economy. While uncertainty has led to less spending, it has also led to a surplus in inventory and free cash flow for U.S. companies. In a scenario where even a minor trade agreement between the U.S. and China is reached, all the pent-up demand in those stored inventories and excess cash could spur the global economy back into expansion. In that world, our current bull market could easily be extended for another couple of years, and there is significant political pressure on President Trump and economic pressure on President Xi to make that happen.
Also, even if the trade war continues, it is possible for the U.S. to dodge a recession like we did in 2012 and 2013. During those years, a number of nations abroad fell into a light recession, but the U.S. continued to expand. Given that we are less reliant on trade than most of the rest of the world, this is still a very possible scenario.
3rd Quarter Market Performance
In terms of market performance, the third quarter results were somewhat mixed. U.S. large company stocks (S&P 500) were up 1.7%, while the Russell Mid-Cap index rose just 0.5%, and the Russell Small Cap index declined -2.4%. International stocks in the developed markets of Europe and Japan, as measured by the MSCI EAFE index, declined modestly by coming in at -1.1%, while the MSCI Emerging Markets benchmark was most impacted by trade war discussions and declined by -4.3%. Falling interest rates led to bonds giving the best return of 2.3%, based on the Barclay’s Aggregate index.
For the year-to-date period through September 30, 2019, overall returns have been very strong with the broad U.S. stock market (Russell 3000 Index) outperforming the non-U.S. stocks (MSCI ACWI Ex U.S. Index), returning 20.1% and 11.6%, respectively; meanwhile, bonds posted a very respectable 8.5% return for this same period.
“Plenty to Worry About, but Not Much to Do”
Our villains and heroes appear equally matched, leading us to an overall neutral stance on the economy and markets. “Plenty to Worry About, but Not Much to Do,” as legendary investor Byron Wien titled one of his recent articles. I feel that sentiment is a great representation of our current predicament. Investors who try to go to cash during volatile times are analogous to the token character that separates himself from the group in the horror film—usually a bad idea, yet there is one in most, if not all, “thrillers.” Timing the market is notoriously difficult to do. As Peter Lynch famously said, “Far more money has been lost by investors trying to anticipate corrections, than lost in the corrections themselves.” And we agree. Typically, the investor who holds strong and sticks to their investment plan will end up with a treat when the dust settles.
Joshua Miller serves as Senior Investment Analyst for Warren Averett Asset Management. His primary responsibilities include investment market research, portfolio construction and analysis and money manager due diligence. Click here to learn more about Joshua or to reach out to him directly.
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