December Investment Comments
As we look toward year-end, global stock markets have had a remarkable year despite tepid growth outside the U.S.
Stock markets in the U.S., Japan, and Germany are up greater than 20%. China’s index has also risen by more than 20%, but remains well below its springtime high for 2019 and far behind its record high from early 2018. Canada’s major index gained 15% so far this year. Even the U.K. is up in the high-single digits despite all the commotion surrounding Brexit. These returns are in local currency. Therefore, U.S. investors in overseas markets have experienced lower returns because of the strength of the dollar versus other currencies.
U.S. economic growth is hovering around 2%, down from 2.9% for 2018 but well above other developed economies. Europe experienced 0.8% growth in both the second and third quarters even as certain key economies are flirting with recession. GDP growth in Canada and Japan is running at 1.3% with the caveat that an October 1st sales tax increase in Japan will likely lead to weak economic conditions judging from reactions to past tax increases. Growth in India was 5%, but trends appear to be slowing. In China, 6% GDP growth was the slowest in 27 years. Anecdotal reports from companies doing business in China paint an even less optimistic portrait of economic conditions there.
Slowing economies appear to be feeding off each other, with the U.S.-China trade skirmish serving as a catalyst. Ironically, since the U.S. is perhaps the least dependent on trade of the major economies, U.S. growth seems to be less affected than other countries which have become collateral damage. Chinese trade, both imports and exports, has trended into negative territory. As Chinese exports to the U.S. decline because of tariffs, it is buying less from other countries.
Bond yields have picked themselves up from the floor. Yields on 10-year U.S. Treasury bonds began the year at 2.6%, fell to less than 1.5% in August, and recently exceeded 1.9%. Global bond yields have followed similar patterns. These indicators are relevant because ultra-low bond yields are an indicator of weak investor sentiment and recession fears. These fears were exacerbated over the summer when the U.S. Treasury yield curve became partially “inverted.” A partial inversion means that yields on some short-term bonds exceed yields on longer-term bonds. This condition precedes most recessions, but also sometimes happens without a subsequent recession. While some of the fears are well-founded in certain countries, we never saw sufficient signs of concern in U.S. economic statistics.
We maintained confidence in the U.S. economy because of continued strength in consumer spending, which powers 70% of the economy. Third quarter spending rose at a 2.9% rate compared to a 1.9% growth rate for the economy as a whole. Another measure of spending, overall retail sales, grew at a 6% annualized rate in the quarter.
A weak factory sector is partially offsetting a strong consumer. Some statistics were affected by a long 40-day strike at General Motors, which has now been concluded. However, we’re not detecting a lot of optimism in the factory sector as reflected in sluggish manufacturing statistics and discouraging comments from many individual companies.
Markets have reacted positively in recent weeks to rumors that the U.S. and China may be able to work out a “skinny deal” on trade. Such an agreement would be limited rather than broad. A partial resolution to the U.S.-China trade battle would likely help factory sentiment, and ultimately manufacturing growth, worldwide. Personal volatility aside, President Trump’s most significant policy shortcoming, in our view, has been the drama over trade. Finding a way to declare victory, however modest, in the trade wars would be a predictable election year move.
The stock market has also been aided by three Federal Reserve rate cuts in recent months. Its recent announcement suggests a pause in interest rate changes, possibly reflecting an economic tone that is less threatening than the Fed perceived when it started cutting rates this summer. It previously promised to “act as appropriate” to continue the economic expansion, implying further rate cuts. Now, the Fed indicates it will monitor economic activity as it “assesses the appropriate path” regarding rates. This new reference is “FedSpeak,” implying flexibility rather than a bias toward cutting rates as before. The stock market tends to do better when rates are falling than when they are rising. Considering that the Fed last raised rates almost a year ago before abruptly and uncharacteristically changing course by cutting them, we are likely a ways off from higher rates. Adding further evidence to this view, the Fed also recently began buying Treasury bonds again, another form of monetary stimulus. Steady growth and stable inflation create the ideal environment to foster patience by the Fed.
And of course we are entering a U.S. election year. The market tends to perform best in the third year of a presidential cycle, which was 2019. The next best year of the cycle is the election year itself, which, if history holds, bodes well for a solid 2020. Stock prices are high, but economic growth appears stable and a partial trade deal with China would help global growth.
We wish you all a wonderful holiday season, and a safe, healthy, and prosperous 2020!
Scott D. Horsburgh, CFA