August 2019 Market Commentary

Global equities finished the month lower as investors became more concerned that the growing trade dispute between the U.S. and China was pushing the global economy ever closer to a recession. In response, investors sought safety in risk-free sovereign bonds and gold. As a result, gold climbed more than +9%, while sovereign bond yields fell to record lows. Concerns about the inverted yield curve in the U.S., and uncertainty regarding whether and how the Fed might respond to the deteriorating economic conditions contributed to volatility during the month.

The following table contains a summary of August and year-to-date market performance:

Index August YTD Index  August YTD
S&P 500 (Total Return) -1.58%  +18.34% MSCI All Country World (Net) -2.37% +13.80%
MSCI EAFE (Net) -2.59% +9.66% Bloomberg Barclays U.S. Agg +2.59% +9.10%
MSCI Emerging Markets (Net) -4.88% +3.90% 60/40 Blend* -0.39% +11.92%

*60% All Country World Index / 40% Bloomberg Barclays US Aggregate Bond Index

U.S. equity markets saw continued elevated levels of volatility in August with half the trading days marked by moves of +/- 1%. Performance for the month was driven by changing expectations about the state of U.S.-China trade relations and concerns about the increasing risk of recession. President Trump announced new tariffs on $300 billion of Chinese imports, causing a sharp sell-off in equities. However, after a new round of trade talks was announced, equity markets rebounded sharply to close the month, highlighting the yo-yo fashion markets continue to exhibit.

As statements from the Trump administration and the Fed regarding trade and interest rate policy continue to dominate media headlines, deteriorating economic data does provide a basis for concerns about the future health of the global economy. While various measures of economic data point to trend-level growth, below-trend growth is evident in the U.S. and China. The Eurozone, on the other hand, is confronting what many believe is an economy mired in recession.

In the U.S., the Index of Leading Indicators fell by 0.1% in both May and June before increasing by +0.5% in July, suggesting the economy will continue to grow albeit at a slower pace from current levels in the year ahead. The conclusion is drawn from evidence that job and wage growth have continued to underpin consumer spending, while “the manufacturing sector continues to exhibit signs of weakness amid a negative yield spread for a second consecutive month.”[1] The overall U.S. Manufacturing PMI recently fell from 51.7 to 51.2, suggesting that U.S. manufacturing continues to grow, albeit at a declining pace. Hidden in the aggregate PMI number is evidence that new export orders are in decline, as CapEx continues to collapse (due to the trade war), putting pressure on continued job growth. A measure of weekly average hours worked recently fell. No trend is observable yet, but historically, employers have cut workers’ hours before beginning lay-offs. With record-low unemployment and wages rising faster than inflation, consumer confidence remains strong but is showing some signs of turning over. The “Present Situation” measure of consumer confidence remains at its highest level in 19 years, but the “Expectations Index” that captures consumers outlook for income, business and employment over the next six months fell from 112 to 107 in August. The fall was driven by declining optimism about short-term prospects for employment and income, with increasing pessimism driven by consumer concerns about the implications of new tariffs on jobs and prices.

Germany, the driver of growth in the European Union, is “on the edge of recession” with GDP falling from 0.9% to 0.4% from Q1 to Q2, hurt by shrinking exports and manufacturing and falling investment spending. Concerns that weakness in manufacturing will seep into services and consumer spending has led a measure of economic sentiment to drop to its lowest level since 2011. The ECB is set to provide more easing, but it has also stated monetary policy alone cannot save the EU, that expansionary fiscal policy is necessary, and as of now, there are few signs it is coming. In China, the slowest growth in 27 years has led China’s Central Bank to ease monetary policy and introduce fiscal measures, including tax cuts to stimulate spending. However, the fall of the yuan beyond the psychologically significant 7 level against the U.S. Dollar was a considerable irritant to investors, who believe China’s” currency manipulation” (according to the U.S. Treasury) will lead to continued deterioration of the global economy.

As investors increasingly recognize that growth is slowing across the globe, their rotation from equities to risk-free sovereign bonds has had a measurable impact on U.S. Treasury yields and returns. With more than $15 trillion of global sovereign bonds trading at negative yields, foreign and U.S. investors have sought out U.S. Treasury bonds that generate positive nominal yields. The increasing demand has pushed bond prices higher and yields lower. The 10-year U.S. Treasury Bond yield has fallen from a post-crisis high of 3.2% last November to approximately 1.5% today, less than the 2-year Treasury bond yield, and leading to an inverted yield curve that has spooked investors and forced the Fed and global central banks to cut rates.

Declining bond yields in the U.S. and across the globe indicate that markets believe economic growth is slowing. With interest rates already low, it is unclear to investors how much impact monetary easing can have. S&P 500 earnings are expected to fall for the second straight quarter and are expected to fall in the third quarter as well. A near-record number of S&P 500 companies have issued negative earnings guidance for the third quarter. With the current recovery over ten-years old, economic and earnings growth is unlikely to accelerate without a solution to global trade disputes. In the absence of a reacceleration of global and U.S. economic growth, The Caprock Group sees limited upside opportunity in equities at current prices in the medium-term.  As a result, Caprock reiterates that clients continue to rebalance to our modestly under-weight target equity allocation recommendation.