There is no denying that the economic environment isn’t as robust as it was 12 months ago. We continue to recommend positions in core fixed income, infrastructure and alternative assets to add ballast to portfolios, given relatively high stock valuations and lower expected earnings growth.
US Economy: Consumers OK.
US consumers continued to spend (+0.1% in Aug.) and find job opportunities (3.7% unemployment). But businesses have grown cautious; their spending was revised downward -1.4% in Q2 and US manufacturing expectations hit the lowest level in 10 years.
US Stocks: Small-cap rebound.
Optimism about the resumption of US-China trade talks in October and expectations for a Fed rate cut sent most US equities higher. Small-cap stocks, which have been lagging, saw a small rebound in relative return and were the top domestic performers for the month.
Foreign Stocks: Value overseas?
Non-US developed equities outperformed with strong results in both Asia and Europe. While the economic fundamentals aren’t particularly attractive relative to the US, more investors have been attracted to the cheaper valuations following the runup in US stocks.
Fixed Income: Lower rates, prices in check.
The Fed cut interest rates for the 2nd time in 2019 (25 basis points in mid-Sept.), citing deteriorating global economic conditions and tame inflation. Weakness in US manufacturing may give the Fed reason to lower rates again in October if inflation doesn’t continue to creep upward.
Real Assets: Infrastructure on top.
Infrastructure assets led the real assets category in Sept. Over the last few months, less economically sensitive, “pure play” infrastructure companies outside the energy supply chain have improved both the diversification and return profiles of portfolios as market jitters have increased.
Alternatives: Managed futures lag.
Hedge fund strategies have quietly posted positive results the last few months. That said, managed futures strategies struggled greatly with volatility in the fixed-income markets, with US Treasury rates spiking only to fall back down by month end.
Equities Total Return
|U.S. Large Cap||1.9%||20.6%||4.2%|
|U.S. Small Cap||2.1%||14.2%||(8.9%)|
Fixed Income Total Return
|U.S. Agg. Bond||(0.5%)||8.5%||10.3%|
|U.S. High Yield||0.3%||11.5%||6.3%|
|Munis Broad Mkt||(0.7%)||7.1%||8.7%|
Non-Traditional Assets Total Return
|Overall HF Market||0.4%||5.9%||0.0%|
|Gold Spot $/OZ||$1472||$1292||$1193|
|U.S. Dollar Index||92.3||91.4||90.4|
There is no denying that the economic environment isn’t as robust as it was 12 months ago, and this has been underscored by corporate America’s waning enthusiasm. Acknowledging this, the Fed saw fit to cut interest rates (as we anticipated) and another cut in October is now being priced in by investors with fairly high certainty. Still, the Fed’s dot plot suggests no more rate cuts from now through 2020.
It is possible that Q4 will be a bumpy ride for investors as markets come to grips with the Fed not necessarily being there to come to the rescue with rate cuts. What might tip off that volatility?
Well, the combination of relatively high stock valuations and lower expected earnings growth gives us pause. Additionally, progress in US-China trade negotiations seems to boost markets only to be snuffed out a short while later. It is hard be confident in a near-term resolution, even if an agreement is in the best interest of both China and the US. At this point, it appears investors are unconcerned with the potential impeachment of President Trump, although this could change.
In terms of positioning, we remain biased toward risk-reduction in acknowledgment of where we are in the economic cycle and continue to recommend maintaining positions in core fixed income, infrastructure and alternative assets to provide ballast to portfolios. Also, while interest rates did come back down, the quick spike in Treasury yields mid-month highlighted the value of fixed-income investments with limited interest rate risk and why we continue to hold them.