HighTower Bellevue 2019 Third Quarter Market Commentary
Dramatic Rally in US Bond Market Yet US Equities Hold Their Impressive YTD Gains
The third quarter of 2019 ended quietly in the United States Financial markets, yet the quarter provided several interesting market surprises. The U.S. Bond market rallied 6.6% as measured by the 10 Year Aggregate US Bond Index, as investors sought the safety of U.S. backed debt. The 10 Year Treasury dropped to a low of 1.51% and YTD the Long-Dated Bond Index has jumped over 20%.
YTD 2019 10 US Treasury Yield
The rally in the bond market caught most U.S. investors in short dated debt instruments off guard. U.S. Financial markets during the third quarter held their own as measured by the S&P 500, climbing 1.6% and is ahead 20.6% year to date, turning in its best three-quarter performance since 1997 per the Wall Street Journal. International markets were down slightly during the quarter and the best performing asset classes during the quarter were utilities (9.3%), consumer staples (6.1%) and real estate (7.7%). Energy and the price of oil bounced around during the quarter and the energy sector fell –6.3%, generating the quarter’s worst sector performance. Technology still leads all sectors thru the first three quarters of 2019 gaining 31%.
S&P 500 5 Year Graph
Even with the steady market returns of the third quarter, there are several reasons why investors are nervous heading into the final three months of the year. The most notable of which is the memory of the fourth quarter of last year or 2018, when investors witnessed the financial markets tank 19.8% during November and December as investors were concerned the Federal Reserve had over tightened interest rates and the trade war with China would erupt into a prolonged trade dispute, disrupting economic activity around the globe.
Unfortunately for investors we are beginning to see some of those same fears play out again. The slowdown in economic activity in the United States and abroad threatens the sustainability of the longest bull market cycle in U.S. financial market history. Recall the 10-year-old bull market rally has been driven by a global economic advance helped by China and a 20 -plus year decline in US interest rates and very muted inflation. Advances in technology continue to help place downward pressure on prices and that has aided the long-standing bull market. In addition, even with the China trade dispute and US and Chinese tariffs impacting economic global economic activity, U.S. GDP in the third quarter is expected to remain positive. Second quarter U.S. GDP growth registered 2.1%, and first quarter GDP growth advanced 3.1%.
Market prognosticators claim the financial markets are driven up or down based on the expectations for interest rates, inflation and earnings. We tend to agree and think the earnings part of the equation is getting more and more difficult to predict, especially if the trade war with the United States’ largest trading partner remains unresolved and the anticipated and advertised tariffs begin to impact earnings. Recent news suggests we may have at least a truce between the U.S. and China, essentially pushing off a resolution on the main sticking points, but coming to terms on enough items to avoid the October tariff hikes. December’s remain in play. In addition to trade, the financial markets in the United States are also grappling with the inverted yield curve which usually predicts a pending slowdown or recession and the idea that President Trump may be heading for an impeachment inquiry over his dealings with Ukraine.
If the turmoil in Washington leads business owners to hesitate regarding their investments and U.S. consumers pair back their spending plans, it seems increasingly likely we are headed for a recession in the United States. The Federal Reserve is doing everything it can to advert a recession in the United States and has been quick to reduce interest rates. In addition, consumer spending remains strong and consumers make up two thirds of all economic activity in the United States. We did just receive the September 2019 Manufacturing ISM Report on Business PMI at 47.8% which indicates contraction in the manufacturing sector. How much longer can the Federal Reserve come to the rescue of the financial markets by lowering interest rates in the United States? At some point lower rates won’t matter, and in essence the inverted yield curve.
Stocks remain ahead for the year nearly 20% in the United States and technology stocks continue to shine. 5G is beginning to roll out across the globe and that should help the cell phone companies and manufactures. In addition, cloud-based computing has created a whole new industry for Amazon and Microsoft and many other new Cloud based software companies. Stock valuations relative to bonds remain attractive and that continues to lend support to the stock market at these levels. That can all change in a New York minute or quicker if earnings slow, business confidence declines, and interest rates continue to fall inverting the yield curve further. (Full disclosure: HighTower Bellevue owns stock in both Microsoft and Amazon for some clients and personally.)
While recessions are not a good thing for equity prices in the short-term, they do act as a catalyst to weed out the weak players in the stock market and as long-term investors we understand the value of holding great money managers and stocks for our clients in both good and bad markets. Recessions while difficult to stomach, last on average 14 months and the financial markets generally turn up 7 months in. While we don’t have a crystal ball, we think a recession today will be much less sever compared to the Great Recession of 2008, when the financial system in the United States was on the verge of collapse, and equity prices declined roughly 50% from peak to trough and bonds fell 20-25%. Banks in the United States are well capitalized and interest rates around the globe are at very low levels with very few signs of inflation. There are others on Wall Street who think the bull market may continue into 2020 and some are predicting a strong finish to 2019. If you are concerned about your portfolio please don’t hesitate to give either myself, Lars, Dan or Mike a call. Your allocation is what drives your results and we can adjust your portfolio quickly assuming you desire to make a change. After all we are experiencing one of the greatest market advances of our lifetimes.
As human beings, we’re incredibly adaptable, intelligent, and forward-thinking. At the same time, about the worst design you could ever imagine to function as an investor is the human brain.
It’s an interesting phenomena that the species responsible for creating financial markets are not only poorly suited to take advantage of it, but our natural instincts cause us to be terrible at long-term financial decision-making.
Simply stated, we can all look to the “fight or flight” mentality, and its roots in pre-historic times. If there were two people, two distinct bloodlines, and they heard an unknown noise in the bushes, one of them may run away and the other may stick around to see what it is. The outcome here is that the bloodline with the “fight” mentality, is basically extinct. Because in those cases where the noise was a lion, or a bear, or any other dangerous mammal, the surviving bloodline is the one who ran away.
It’s in our very nature to run at the first sign of danger. The difference being, back then, that danger was often life-threatening. The danger in financial markets is not. (If it is, then you should consider an update to your strategy) In fact, the danger in the stock market in the US is often a temporary setback, or delay on the way to higher prices.
The fear that we experience during times of geopolitical instability, negative headlines and uncertainty around the overall direction of the economy is very real, and very visceral. We FEEL the reaction. Our physiology actually changes as a result of the information we consume.
The antidote to that fear is a long-term, pragmatic approach. If you can remain steadfast in your approach, and maintain conviction through ups and downs, you’re more likely to see the results that you had planned for. If you run at the first sign of danger, as we head into a period that has historically seen volatile swings in stock market prices, you’re putting your financial future at risk.
Don’t hesitate to reach out to your financial planning team. Don’t be ashamed of the feeling or desire to “not want to be in the market” during times of volatility. We all have these feelings, it’s natural. It’s human. Your fiduciary advisor is there to help guide you through the rough times, and to assist you in staying on your path. While the past does not predict the future, history has rewarded those who were able to remain steadfast in their approach.
With the current over-hang that faces us in the nightly news and throughout the day from our instant news sources, we are happy that the markets have held up so well this year. As you can gather from the above data points, there are both positives and negatives that fill up the ledger. We will certainly have more insight on the trade status when we reconvene for our Q4 newsletter in January, but the recent trade news was at least promising, and the markets reacted accordingly. It shows the pent up demand from investors for clarity. The unknown is damaging for corporations as they budget their capital expenditures, including M&A, expansion, R&D spending, employment, etc. It is also damaging for the individual investors like you and us. We might think twice before we buy the new car, remodel the house, make a trip to the mall. This all flows back to company sales and earnings, which ultimately drive the markets.
As we head into the 4th quarter, we hope to get clarity on trade, the Federal Reserve action or inaction, Brexit, and Middle East conflict. Clarity on these should allow investors to focus on bottom-up fundamental analysis, and hopefully remove some of the over-hang that is slowing growth. It will not however clear up the next thing we all have to factor in, the 2020 elections. We will look at some of the potential impacts in a quarter or two when we get closer. In the meantime, we remain somewhat positive on the markets through year end if some of the uncertainty gets cleared up and individual and corporate sentiment improves. We will continue to look for opportunities in both our equity and fixed income allocations as market dynamics shift.
We wish you all a wonderful fall and Holiday season. Again, please contact us if you have any pressing concerns or would like to reevaluate your strategic allocation.
Lars Knudsen, Dan Stober, Randy Williams-Gurian, Mike Policar
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