Investment Thinking

Third Quarter 2019 Market Review: Equities Grind Higher Amid Signs of Slowdown

US equity prices rose modestly in the third quarter, building on the spectacular gains in the first half of 2019. The S&P 500 Stock Index inched up 1.7% in Q3, bringing its year-to-date gain to 20.4%. Globally, the MSCI ACWI was flat for the quarter, but up 16.1% in 2019. Dogged by the escalating trade war with China, the MSCI Emerging Markets Index fell 4.25% in the quarter, shaving its year-to-date gain to a more modest 5.9%.

Mounting evidence of economic weakness led to a sharp drop in interest rates and strong gains for fixed income securities. US bond indices all registered solid gains in the third quarter, as the bellwether 10 year US Treasury note yield fell from 2.0% to 1.67% at quarter’s end.

Despite the strong rebound in equity prices in 2019, it might surprise investors to know that the S&P 500 has trailed the return of the 30 year US Treasury bond by more than 20 percentage points over the trailing twelve months ending in September! Owing to the cruel math of compound returns, the near 20% decline suffered by the S&P 500 in Q4 2018 requires a 25% rebound just to get back to even. As a result, even the sharp gains enjoyed by US equity investors this year has resulted in only a 4.25% return over the trailing 12 months, while the 30 year bond soared nearly 30% as interest rates sharply declined.

Other interest-sensitive asset classes, such as real estate investment trusts (REITs) and infrastructure stocks continued to build on their first half gains. Both the Dow Jones Global REIT Index and the Dow Jones Global Infrastructure Index delivered gains in excess of 20% this year. Energy prices were volatile in September after an attack allegedly perpetrated by Iran did significant damage to one of Saudi Arabia’s largest oil processing facilities.

Outlook and Strategy

As we enter the fourth quarter, investors are struggling with three dominant themes: 1) the ongoing impacts of the trade disputes between the US, China, and our other major trading partners; 2) growing evidence of a decline in manufacturing activity and the probability of a resulting recession; and 3) the effectiveness of global central banks’ ability to provide economic stimulus to offset the effects of the first two.

Up to this point, equity and fixed income investors have arrived at different conclusions as to the economic impact of these various forces. Equity investors seem to believe that, at some point in the not-too-distant future, the trade wars will be resolved with each side declaring a partial victory. This should provide at least a psychological boost to equity prices. In the meantime, the Fed stands ready to further lower interest rates should US economic growth stall.

On the other hand, fixed income investors are viewing the economic glass as decidedly half-empty. A near insatiable demand for the perceived safety of high quality bonds has driven yields to below zero on more than $15 trillion of global debt. At least part of the motivation for owning a security that is guaranteed to return less than your investment is the notion that rates are destined to fall further (typical in a recession scenario as credit demand evaporates), providing a capital gain to existing holders. While the 10 year US Treasury note flirts with decade-low yields, some observers are even warning of the possibility of negative yields on US debt.

In their search for yield, fixed income investors have gravitated toward higher risk securities, including junk bonds, preferred stocks, and emerging market debt. With the dividend yield exceeding the yield on treasury notes, some income-oriented investors have grudgingly moved back into the stock market. Should market conditions deteriorate, these investors may exacerbate the volatility on the downside as they look to protect capital.

We side with equity investors at present. The signs of a global slowdown have been apparent to most observers for many months now. More recently, US manufacturing has succumbed to the weakness apparent in other economies, but the reliance of the US economy on manufacturing activity is relatively small. Our economy is powered by consumer spending, which has remained solid throughout 2019, buttressed by continued job growth and real wage gains. While we acknowledge the threat of slowing global growth, we believe that the odds favor a slower growth, non-recessionary US economic trajectory.

Importantly, there has been a notable shift in investor preferences over the past few weeks. For the first time in a long while, both developed international and emerging market equities are outperforming the US averages. Such a transition may indicate that economic activity is showing signs of stabilization in overseas economies. That, coupled with attractive relative valuations, is drawing money toward these long-overlooked opportunities. Progress on the trade issues would only further enhance their appeal. Our current global equity allocation reflects our preference for US and emerging market equities, and a tilt away from European stocks.

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About Bruce D. Simon, CFA, CPWA®

Bruce is a Partner and the Director of Research at the firm. In addition to working directly with a number of family clients, Bruce serves on Ballentine’s Investment Management Committee, which is responsible for the oversight of all of the investment activities for the firm.

 

This report is the confidential work product of Ballentine Partners. Unauthorized distribution of this material is strictly prohibited. The information in this report is deemed to be reliable but has not been independently verified. Some of the conclusions in this report are intended to be generalizations. The specific circumstances of an individual’s situation may require advice that is different from that reflected in this report. Furthermore, the advice reflected in this report is based on our opinion, and our opinion may change as new information becomes available. Nothing in this presentation should be construed as an offer to sell or a solicitation of an offer to buy any securities. You should read the prospectus or offering memo before making any investment. You are solely responsible for any decision to invest in a private offering. The investment recommendations contained in this document may not prove to be profitable, and the actual performance of any investment may not be as favorable as the expectations that are expressed in this document. There is no guarantee that the past performance of any investment will continue in the future.

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