For the week ending October 4, 2019
This publication is provided by BMT Wealth Management.
Stocks close out the quarter with best year-to-date gains in over 20 years, data-filled week creates volatility, but little net change in stock prices
The S&P 500 Index closed out the first three quarters of the year on Monday with a year-to-date advance of 20.6%, registering its best showing over the first nine months of a year since 1997. A flurry of economic releases created a great deal of volatility over the week, but little in the way of meaningful damage to stock investors. While the S&P 500 closed down for its third consecutive week, the loss was held to a negligible -0.3%.
Important economic readings on Manufacturing and Non-Manufacturing (Services) were released, both of which registered a decline from the prior month. Still, the September jobs report was largely indicative of a healthy economy. In total, the data support our belief that while growth is clearly slowing, a recession is unlikely in the near future, while the Fed will remain accommodative.
Manufacturing and Services gauges moved lower in September. This past week saw the release of both the ISM Manufacturing and the ISM Non-Manufacturing (Services) Indices. Both measures moved lower from the prior month, with the manufacturing index dipping further below the reading of 50, which signals a contraction. While the Non-Manufacturing reading also declined, at 52.6 it remains above the level of contraction, and represents a far larger portion of the economy (roughly 80%).
Source: FactSet, Inc.
The Non-Manufacturing Index has an inception date of June of 1998, and the performance of these two gauges since that time is depicted in the chart above, with recessions so noted. While the Manufacturing Index moving below 50 is clearly noteworthy, it has done so at least four other times over the prior 20 years, without providing a signal as to a forthcoming recession. Conversely, while the sample period is limited to just two recessions, a decline of the services sector meaningfully below 50 has proved more telling. We remain watchful on this front, but note that the component parts of the Services Index (with the exception of imports) are still universally growing, albeit at a slower pace.
Fed likely to do more to support the economy. The deceleration in the U.S. economy, which is in no small measure due to current trade tensions, has forced the Fed to reverse course in an effort to support the U.S. economy. Since its final increase (last December) in what turned out to be nine rate hikes, the Fed has now cut rates twice, first on the final day of July and again on September 18. The Fed meets twice more this year, late this month and again in mid-December. We believe more accommodation is on the way in 2019, as does the market, with Fed Futures now showing a roughly 70% chance of a cut at the next meeting.
It should also be stressed that it is widely acknowledged that any Fed action can take as long as twelve months to fully flow through the economy. With the first cut occurring less than ten weeks ago, the actions taken to-date should provide ongoing stimulus. This lag effect, and the Fed action yet to come, creates a positive backdrop of ongoing support for the U.S. economy.
Better news on the trade front coming. The escalating trade tensions between the U.S. and China, the world’s two largest economies, have been primarily responsible for the slowdown in the U.S. economy. The standoff with China started in early 2018 from the humble beginnings of tariffs covering only solar panels and washing machines. Since then, the United States has steadily increased tariffs on a greater number of goods (now covering hundreds of billions of dollars), with China responding likewise.
While this past week showed the U.S. moving toward imposing tariffs on $7.5 billion of European goods, we believe that the news on trade will get better in the near future. President Trump knows that this issue has created headwinds, not only to the U.S. economy but also for his chances of re-election. The U.S. and China are scheduled to meet in Washington, D.C., late this week (October 10-11) and, while we are highly doubtful any wide-scale deal will be struck at that meeting, we are confident that after almost two years of progressively worsening news on trade, the narrative is finally poised to improve.
Consumer spending likely to hold up. By definition, consumer spending should largely be a function of employment and wage growth, coupled with consumer confidence, less savings. At least with respect to the first two variables of this equation, last Friday’s jobs report was supportive. This is critical to the ongoing expansion of the U.S. economy since consumer spending accounts for roughly 70% of GDP.
Source: FactSet, Inc.
The actual unemployment rate declined from 3.7% to 3.5%, a level last matched in 1969. Yearly wage growth, while relatively modest at +2.9%, was in the sweet spot of growing better than inflation (an increase in real wage levels), but not at a pace that would give the Fed pause with respect to further rate cuts.