Fall 2019

Quarterly Commentary

PDF Version

Our economy is bifurcated to say the least! Our consumer-driven service sector has benefitted from both wage gains and low interest rates. In fact, the most recent ISM Non-Manufacturing (Service) Index remained in expansion territory with 13 of 18 industries in the index showing growth. The L&G investment team sees a healthy U.S. consumer as vitally important to the economy & market.

Conversely, the manufacturing sector of our economy, while small in size at a low-teens percentage of our total economy, has most professional investors concerned. The ISM Manufacturing Index is now in contraction territory with 15 of 18 industries declining! We expect this economic tug-of-war will continue until we get more clarification on China trade talks as well as company guidance post-earnings season. Buckle up for a bumpy ride!

Economy Positives

Consumer, consumer, consumer!
The consumer is keeping the American economy afloat. Retail sales have expanded at a 0.5% rate on average over the last three months and personal consumption expenditures have had only one down month in the last two years. This strength has economic bears perplexed.

Multi-decade low in the unemployment rate!
The jobs market remains strong. While payrolls have slowed due to manufacturing weakness, gains in healthcare, private education and state & local government have led the unemployment rate down to 3.5% – its lowest level since the 1960s.

Housing is back in the spotlight.
The decline in mortgage rates from 5% last year to near 3.7% today is elevating demand. Existing home sales, after 16 months of declines, have bounced recently even though supply remains tight. New housing starts ripped 12% higher in August – marking the biggest gain since 2007!

Economy Negatives

Will a global cold lead to a U.S. flu?
The head of the International Monetary Fund recently said in a speech that “The global economy is now in a synchronized slowdown”. This was followed by the World Bank President “…expect growth to be weaker hurt by Brexit, Europe’s recession & trade uncertainty”. Not good!

The yellow caution flag is waving on services!
While the service sector is still expanding, the short-term trend does not have us overly optimistic. The September report showed weakness in orders, business activity and employment – its three most critical components!

Too much of a good thing?
A strong U.S. dollar has long been viewed as a sign of economic strength. However, recent dollar strength (12-year highs) has been a significant drag on manufacturing as it increases our costs and makes us less competitive globally. U.S. goods producers would love a reprieve!

Financial Market Negatives

Peak political theatre!
The significant ramping up of political rhetoric out of D.C. has many market participants on edge. While some may say “we have seen this movie before”, the fact is the next 12 months will likely experience above-average market volatility as we progress through the election year.

The not-too-cheap market.
According to Goldman Sachs, the stock market’s median valuation metric is in the 84th percentile – certainly not cheap by historical standards. However, interest rates are much lower too and one could make a case that stocks should be trading at a higher multiple!

The unloved global equity market.
Global investors remain firmly in risk-off mode. Since the beginning of the year, global corporate & government bonds have attracted $331B of inflows versus $201B in equity outflows (yes, outflows!). If the economic slowdown is short-lived, stocks will benefit & the gap will narrow.

Financial Market Positives

Don’t fight the Fed!
In an effort to sustain the economic expansion (&keep the stock market elevated), the Fed cut short-term rates in September for the second time this year. Fed Chair Powell is widely expected to cut interest rates another quarter point in October. Low rates enable higher equity valuations.

Earnings…under promise & over deliver?
Third quarter S&P 500 earnings are expected to be down 3.1% year-over-year. However, last quarter’s expectations were negative going into ‘earnings season’ and ended up positive 3.2%! Sometimes widespread pessimism is a good thing as Wall Street is often wrong.

Low rates = cheap access to capital = shareholder-friendly actions.
With investment grade borrowing costs near historic lows, companies continue to issue record new debt. Even Apple, which has $210B in cash, took advantage by issuing $7B in debt so it could increase share buybacks and raise its dividend.

Certain information contained in this commentary is based upon proprietary research and is general in nature. It is not intended to be investment advice. The S&P 500 Index is a widely recognized capitalization-weighted index that measures the performance of the large-capitalization sector of the U.S. stock market. Index performance information was furnished by sources deemed to be reliable and is believed to be accurate but not guaranteed. This information is subject to correction. The index referenced is unmanaged and a direct investment is not possible. Past performance does not guarantee future results.