Change Is In The Air

Autumn 2018 Market Commentary


With U.S. stock markets breaching record levels and a trade skirmish brewing, it is challenging to develop a framework to rate investment policy over the next few months. While it is nearly impossible to target a level of the S&P 500 Index in 12 months’ time or predict the interest yield on the 10-year U.S. Treasury bond in 2020, it is possible to gain an understanding of the prevailing economic and market conditions to make reasonable judgments about the risks and opportunities investors will face in the near term.

We stipulate that the U.S. economy relative to the rest of the world (ROW) is booming. The biggest economy in the world seems set for the second consecutive quarter of greater than 4% annualized GDP growth. Meanwhile, Europe’s growth slows, and faster growing China struggles with trimming excess debt during a bona-fide trade war with the U.S.  Another given is the profit outlook for publicly traded U.S. companies is solid as the rolling effects of tax cuts and robust conditions continue. There are headwinds in the emerging markets (Turkey, Argentina, Malaysia) as a stronger U.S. dollar makes it more expensive to pay back debt denominated in dollars with profits earned in weakened local currencies. This exacerbates problems in highly leveraged developing economies.

This set of facts is distinct from the prevailing conditions just last year when all regions of the globe grew smartly and in synch. With fiscal stimulus still in the pipeline, the U.S. seems set to continue its winning ways. The level of corporate debt in the U.S., which waned in the wake of the financial crisis, is now growing at rates above the level of economic growth. This probably represents the U.S. economy’s greatest vulnerability, yet compared to ROW, it is relatively modest. Ironically, this gives the Federal Reserve Bank more scope to continue to raise interest rates, removing monetary stimulus amid fiscal support and incipient inflation. With U.S. stock prices elevated, in our view, the continued tightening monetary conditions represents the biggest threat to U.S. equity prices.

In other parts of the globe, current struggles are sowing the seeds of opportunity as prices of Asian and European assets sink in absolute and dollar terms revealing compelling value. At some point, the superior values offered by these markets may spark a rally as the U.S. comes off the boil. Increasing a position in developed markets outside the U.S. should prove fruitful. However, it is likely too early to be aggressive in troubled emerging markets, with a number of shoes yet to drop. Potential spoilers for the immediate future are many, but a possible spike in oil prices stands out. Supplies are at least temporarily constrained by pressure on Iran and choke points caused by a dearth of pipelines near newer production sources. Meanwhile, demand continues to grow at a modest pace. A deepening trade conflict between China and the U.S. is second on the possible troubles list.

The landscape is substantially different now than just a year ago. While we are alert to these changes, we believe a steady approach is the best course of action for now. Stocks should remain near neutral for most investors. Building values overseas may make reallocating toward Japan and Europe over the next few quarters an attractive proposition. Rising yields and deterioration in credit calls for lower than benchmark maturities and an emphasis in government bonds for fixed income investors. As always, we never forget the confidence reposed in us by our clients and look forward to talking with you soon.

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