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ECONOMIC FLASH – Growth Concerns Roil Markets

September 2019

US Economy: Signs of deceleration.

US manufacturing activity appears to be contracting, as the ISM US Purchasing Managers Index fell unexpectedly to 49.1 for August 2019, with results under 50 indicating general contraction. Additionally, the Labor Dept. reported the US added 500,000 fewer jobs than initially estimated for the 12 months ended March 2019.

US Stocks: Small caps sink.

Small-cap equities are underperforming, having lost nearly 5% in August, in what was a down month for stocks in general. Since they operate mostly in the US, one would expect small-cap stocks to outperform given the US-China trade war. However, concern over a US economic slowdown is making small stocks less appealing.

Foreign Stocks: Brexit by November?

Global economic uncertainty buffeted foreign markets. Boris Johnson, the newly elected British Prime Minister, announced that the UK will exit the EU by October 31 — with or without a deal with the Eurozone. If no deal, analysts expect the UK to lapse into recession.

Fixed Income: Argentina near default.

US high-quality bonds continued to benefit from falling interest rates. In Argentina, a surprise election effectively ousted market-friendly President Macri, amid falling economic growth and 55% inflation. While it’s uncertain if the new government will honor foreign-debt payments, the need for new capital may force their hand.

Real Assets: Gold shines.

REITs and infrastructure equities posted positive returns, partly due to falling interest rates. Most commodities were hurt by flagging global economic growth, with the exception of gold. The Midas metal gained 7.5% in August, a nearly seven-year high, on its safe-haven status.

Alternatives: Managed futures bet on trends.

Managed futures managers applying trend-following strategies benefited from the persistent fall in US interest rates/rise in bond prices, leading to outperformance. While positive so far in 2019, over the last few years these strategies have struggled in the absence of persistent trends.

Equities Total Return

AUG YTD 1 YR
U.S. Large Cap (1.6%) 18.3% 2.9%
U.S. Small Cap (4.9%) 11.8% (12.9%)
U.S. Growth (1.0%) 22.8% 3.1%
U.S. Value (3.1%) 13.3% (0.6%)
Int’l Developed (1.1%) 9.4% (3.5%)
Emerging Markets (1.8%) 3.8% (4.4%)

Fixed Income Total Return

AUG YTD 1 YR
Taxable
U.S. Agg. Bond 2.6% 9.1% 10.2%
TIPS 2.4% 9.1% 7.5%
U.S. High Yield 0.4% 11.1% 6.6%
Int’l Developed 2.6% 7.0% 7.6%
Emerging Markets (2.2%) 4.0% 7.9%
Tax-Exempt
Intermediate Munis 0.5% 5.2% 6.3%
Munis Broad Mkt 1.6% 7.9% 8.8%

Non-Traditional Assets Total Return

AUG YTD 1 YR
Commodities (2.3%) 1.9% (5.9%)
REITs 4.1% 26.1% 15.6%
Infrastructure 0.4% 18.2% 11.0%
Hedge Funds
Absolute Return 0.3% 2.2% 0.4%
Overall HF Market 0.2% 5.3% (1.3%)
Managed Futures 2.5% 11.2% 7.8%

Economic Indicators

AUG-19 FEB-18 AUG-18
Equity Volatility 19.0 14.8 12.9
Implied Inflation 1.5% 1.9% 2.1%
Gold Spot $/OZ $1520 $1313 $1201
Oil ($/BBL) $60 $66 $77
U.S. Dollar Index 91.7 91.1 90.0

Glossary of Indices

Our Take

Even if the US economic environment is less attractive today than it was last year or even six months ago, the US appears better situated in the near term than most other developed and emerging markets. With US inflation in check, the Fed is likely to remain accommodative, lowering its key interest rate again this September, given recent job data and what seems to be loss of business confidence due to the US-China trade war. It also seems likely the US would be willing to ease monetary policy when other central banks are doing so globally in both developed and emerging markets.

Meanwhile, Brexit remains a struggle for Europe, while the Argentinian debt crisis and the US-China trade war have spillover effects in Latin America and Asia, respectively. Consequently, the US dollar will likely maintain its strength, even if US interest rates come down further.

In terms of portfolio positioning, we continue to look for risk-reduction opportunities given relatively higher US equity valuations and an uncertain outlook for corporate earnings. At the margins, we recommend larger allocations to core fixed income and infrastructure equities, both of which offer benefits should equity markets continue to slip. Additionally, while we continue to be positive on emerging markets longer term, we are reevaluating our manager exposures in that allocation.