Since our last quarterly commentary, a lot has happened but little has changed. The trade discussions between the US and China continue to ebb and flow, the Fed remains accommodative, the corporate earnings picture remains uninspiring, and US economic growth remains weak (though positive), and politics remain unpredictable. While some economists are predicting an imminent recession, the data still suggests that the economy is in a low-growth holding pattern. Our process acknowledges these risks, but suggests that the market will go on to new highs.
Trade uncertainty has negatively impacted the global economy and US corporate earnings. Europe has been particularly affected as manufacturing as a share of the EU economy is twice that of the US. Recent data from IHS Markit indicates that manufacturing activity in Europe has slowed for the 8th consecutive month; it is likely that parts of Europe are already in recession. US companies that derive the majority of their revenues from overseas have badly lagged those with a more domestic focus, according to data from Factset. Over the past few years, our process has repeatedly caused us to reduce international holdings, eventually eliminating them entirely in December of 2018.
Several important points counter the narrative that the US will slide into a recession in the near term. First of all, the Conference Board’s Leading Economic Indicators are still consistent with a growing economy. The Citi Economic Surprise Index recently hit its highest level since April of 2018. This shows that recent economic data has come in above expectations. Lastly, recessions are most imminent when borrowers are unable to borrow money. However, the first week of September saw the largest ever issuance of corporate bonds which was met with strong demand from investors.
The US stock market itself is showing strong signs that it is likely to go higher. Over the past month, participation data from large, mid, and small cap stocks all made news highs. This is the opposite of what has historically occurred at stock market peaks. Additionally, more aggressive sectors such as technology and consumer discretionary continue to lead over defensive sectors. Furthermore, the yield on the S&P 500 recently surpassed that of 30-year Treasuries for just the 2nd time in history. The other time this happened was in early 2009, near a stock market bottom. Simply put, strong stock market breadth, low interest rates, easy availability of credit, and rampant pessimism are not characteristics of stock market peaks. We continue to recommend that investors review their asset allocation and practice patience.