By: Peter Mueller & Vanessa Wieliczko
As autumn and the final quarter of the year have arrived, so too has both political and market volatility. While markets continue to navigate uncertain political and trade currents, one certainty remains – the U.S. financial markets continue to be the preferred and safe harbor for global capital and investment. As such, while we continue to see opportunity from a valuation standpoint in Europe and Emerging Markets, U.S. equities compose the majority of the equity allocations within most client portfolios.
The U.S. financial markets are the most liquid and stable, and domicile some of the most dominant and innovative businesses in the world. Many of these companies are market leaders in their respective industries, well capitalized, and operate as shareholder friendly businesses that prioritize creating shareholder value by increasing earnings per share, buying back stock, and increasing dividend payouts to shareholders. The U.S. economy has continued to grow this year supported by the strong consumer – benefiting from low unemployment, low interest rates, and a strong housing market which has boosted household wealth.
While these are clearly positives, we have seen some recent weakness in overall economic conditions that cause concern: domestic manufacturing is contracting (manufacturing was 11.6% of U.S. economic activity (GDP) in 2018), initial unemployment claims have increased suggesting softness in the labor market, and global economic growth is flat with some leading countries such as Germany experiencing recessionary conditions. These recent symptoms of economic weakness have pushed the Federal Reserve to reduce interest rates in 2019 with the hope of prolonging the U.S. expansion and maintaining full employment. The Fed’s action on interest rates this year has helped support stock prices in a slow growth environment. We anticipate that the Fed will cut interest rates by 0.25% two more times this year which should continue to support asset prices despite patches of weakening economic data.
The root of slowing global and domestic economic growth is somewhat self-induced – tracing back to the ongoing U.S. vs China trade war. The outcome remains to be seen. The trade war has resulted in tariffs (taxes) on most imports entering the U.S. from China, as well as retaliatory tariffs on exports from the U.S. to China. Tariffs ultimately impact the American consumer – the equivalent of a consumption tax which reduces consumer purchasing power and sentiment. The tariffs also lower corporate profit margins as some of the tariff cost is absorbed by companies in order to defend their respective market share. In our view, tariffs are bad news for global trade, economic activity, and the health of the post-World War II global supply chain system that the U.S. has dominated.
As of this writing, trade relations between the U.S. and China remain strained to say the least, but we have seen some thawing and hopes of working toward a resolution. The current pause in escalation is clearly a positive as both sides continue to negotiate toward a resolution. Time will tell how trade negotiations ultimately play out, but markets are currently pricing in an eventual framework to an agreement that allows global business to move forward without the impediments of large scale tariffs, coupled with increased intellectual property and cyber-security protection. Unfortunately, if trade relations devolve further, recessionary conditions may be on our doorstep sooner rather than later – despite the Fed’s support with low rates.
The truth is, we don’t know when the next market or economic downturn will arrive. Consequently, we remain diligent in our research and continue to seek opportunities to diversify. We continue to position client portfolios to participate in current growth opportunities, while harvesting profit where applicable to maintain long-term asset allocation goals.
We appreciate your continued confidence and support, and as always, please contact your Advisor if you have any questions or wish to discuss.
Sincerely,
Your HoyleCohen Team
