High Level Commentary

MARKET PERFORMANCE-As Of Friday, November 30, 2019

Last 3 Last 12
Major Benchmark Performance:  Months YTD Months
Since: November 6/30/19 12/31/18 11/30/18
As Of: 11/30/19 11/30/19 11/30/19 11/30/19
US Large Cap-S&P 500 3.63% 7.86% 27.65% 16.12%
US Small Cap-Russell 2000 4.12% 9.08% 22.02% 7.52%
Foreign Developed-MSCI EAFE 1.13% 7.76% 18.16% 12.43%
Foreign Emerging Mkts-MSCI EEM -0.14% 6.06% 10.20% 7.27%
US Bonds-Barclays Aggregate -0.05% -0.28% 8.80% 10.81%
Long Treasury-20 Yr+ US Treasury Bonds -0.50% -3.91% 18.58% 25.24%
High Yield-Bloomberg 0.33% 0.97% 12.14% 9.74%

U.S. equity markets for the S&P 500, Nasdaq and the Dow Jones Industrial Average vaulted to all-time closing highs during November due to perceived progress in trade negotiations between the U.S. and China.  The potential trade agreement may postpone planned U.S. tariffs that would go from 25% to 30% on $250 billion of imports.  In exchange, China is expected to purchase between $40 billion to $50 billion of U.S. farm products.  This “phase one” deal is incremental and tariff increases on electronics, apparel and other consumer goods are still in place for December.  Larger issues related to forced technology transfer and theft of intellectual property are further in the future and may not be possible to be achieved.  The Federal Reserve reduced interest rates on October 30th for the third time this year, and the Fed Funds now stands in a range of 1.50% to 1.75%.  The Fed indicated that no additional cuts will be forthcoming unless the economic data turns more negative.

Markets have been strong since the beginning of the year.  On a year-to-date basis, the S&P 500 large cap index is up a solid 27.6%, and the Russell 2000 small cap index is up 22.0% through November 30.  Foreign market performance on a year-to-date basis is positive but has trailed the U.S largely due to stronger economic growth in the U.S.  The MSCI-EAFE developed market index is up 18.2% so far this year and the MSCI Emerging Markets Index is up 10.2%.  Corporate earnings are also providing support for the market.  Although third quarter earnings are down on a year over year basis, they are not down nearly as much as many market participants had feared.  U.S. stocks are also supported by continuing corporate stock repurchases and significant foreign demand.

Treasuries:  Interest rates have been particularly weak so far in 2019.  The 10-year U.S. Treasury bond started the year at a yield of 2.66%, but it dropped to 1.46% on September 4th.  In addition, the 30-year US Treasury fell to an all-time low of 1.94% August 28th.  Since then, interest rates recovered somewhat, and the 10-year is now at 1.78%.  Based on these interest rate declines since the beginning of the year, Long Treasury bonds total return performance was up a hefty 18.6% through November 30 this year as bond prices moved up with the decline interest rates since year-end 2018.  Despite this strong performance, these long bond total returns have been down since September.  High Yield Bonds are up 12.1% YTD based on reduced fears of an imminent recession.

 

Inverted Yield Curve:  This summer market pundits and the financial press loudly touted the risk from an inverted yield curve-the abnormal situation where interest rates on longer-maturity 10-year US Treasuries are lower than interest rates on shorter maturities like the 2-year US Treasury note and the 90-day Treasury bill.  Historically, an inverted yield precedes most U.S. recessions.  More recently, short rates have moved down below the U.S. 10 year U.S. Treasury interest rate, so that the yield curve is no longer inverted.  Although an inverted yield curve may once again be a precursor to a recession, it is important to note that the timing is hard to predict.  Analysis from Credit Suisse shows that a recession occurs on average 22 months after the inversion.  Moreover, stocks often to do well after an inversion with an average gain of more than 15% in the 18 months following the inversion.  This means that an inverted yield curve is not a time to make rash short-term portfolio changes.  Instead, it is more prudent to maintain a disciplined long-term perspective that maintains proper asset allocation, diversification and portfolio rebalancing.

Big Picture:

-Although the U.S. economy has softened modestly this year, the employment situation remains strong.  The payroll report released on November1 showed strong job growth despite the GM auto workers strike.  There were also significant upward revisions to job growth in September and August.  The unemployment is now near a 50-year low level of 3.6%.

-U.S. economic data for consumer spending also remains strong at 2.6% for the third quarter.

-Manufacturing and capital spending in the U.S. have been anemic.

-Although corporate earnings for the 3rd quarter are coming in below earnings from last year, the earnings reports are not as bad originally feared.  The modest growth is a function of the resilient economy and a lower tax rate.  The earnings growth also helps make Price/Earnings valuations more attractive as stock prices are being divided by a much higher earnings level.

– Eurozone 2019 Q3 GDP growth was recently reported at 0.8%, the same level as Q2.  Although the Eurozone economy is weaker than the U.S., they have been able to avoid a recession.  Economic growth is now seen at 1.5% for 2019 compared to 1.8% for 2018 and 2.4% in 2017.

Risk Factors:

-The 2019 federal government fiscal year budget deficit ballooned to $984 billion up 26.4% and up $205 billion from fiscal 2018.  Although total receipts were up 4.0%, outlays were up 8.2%.  Individual income tax receipts were up 2.0% and corporate tax receipts were up 12.3%.  The budget deficit is the result of large government spending increases and the 2017 tax cut law.  One particularly troubling aspect of the budget deficit is the rapidly increasing interest payments on the accumulated government debt.  The federal government spent $380 billion on interest payments on the debt and this will continue to grow rapidly as ongoing budget deficits add to the government debt level.  Moreover, interest rates are low but may well move up in the future, and this will make the interest payments even larger.  It is unprecedented for the government to run such a large deficit during a period of economic growth because spending on unemployment and other safety-net programs are lower and tax revenues are higher.  A future recession will cause even greater deficits due to lower tax receipts and higher safety-net spending.

-The intelligence-community whistleblower allegations regarding efforts to coerce Ukraine has re-energized efforts to impeach President Trump.  If the President were impeached by the Democratically controlled House of Representatives, it is unlikely that the Republican Senate would convict him.  Regardless of how this proceeds, it seems that potential bipartisan initiatives like infrastructure and the passage of the U.S.-Mexico-Canada trade deal are less likely to be completed.  Stocks gained 28% in the year after impeachment efforts were initiated against President Clinton but they dropped 39% in the year after impeachment efforts were initiated against President Nixon.  These impeachment proceedings certainly inject a wild card into an already contentious environment.

-The September 14th attack on Saudi Arabia’s Abqaiq plant caused an oil price spike but oil supplies remain sufficient to meet worldwide demand.  Nevertheless, the attack warns against geopolitical complacency.

-The Wall Street Journal lists the risk of recession within a year at 30%, a level that down modestly from 35% the previous month due to recent positive economic data.  Nevertheless, the recession risk is still higher than a year ago when the risk of recession was seen at 18%.

-Global economic growth has weakened in 2019, particularly in China and Germany.

-China’s third quarter GDP was reported as 6.0%, the lowest level in nearly three decades.

-Germany reported that 3rd quarter GDP was at a weak 0.3%, but better than the negative -0.1% reported for the 2nd quarter.  Germany is particularly weak due to slumping auto exports.

-The UK reported third quarter GDP of 0.3%, modestly better than the -0.2% rate in the second quarter.  Brexit uncertainty continues to weigh on both consumers and manufacturers.

-On a broader basis, Euro area third quarter GDP rose by 0.9%, up from 0.8% in the second quarter.

-The International Monetary Fund released their July update of their World Economic Outlook and it shows a modest reduction in their growth forecast for 2019.  The IMF reduced their global growth expectation down to a level of 3.2% for 2019.  Growth was 3.6% in 2018 and 3.8% in 2017.  They used the term global synchronized slowdown but not recession.

-The UK Brexit withdrawal process began in June 2016 and it continues to cause uncertainty.  Border regulations with Ireland and specific trade terms were not able to be resolved and Theresa May was forced to resign.  Boris Johnson was able to get a withdrawal agreement approved by parliament but was unable to achieve his October 31 deadline.  The withdrawal agreement provisions included a) conditions for orderly exit from the bloc, b), a financial settlement, and c) a plan to avoid a border on the island of Ireland.  Since then, the EU granted a Brexit delay until Jan 31 2020-the 3rd deadline extension.  In addition, the UK parliament approved a December 12 election.   Although Boris Johnson is seeking a clear majority to finalize the Brexit withdrawal, an election victory is not assured and additional chaos may ensue.

For more detail see:

Markets & Economics

Market Performance

Valuation

To summarize, economic growth momentum is currently slowing outside the US and this provides short-term concerns.

Cornerstone maintains significantly more data and graphs than what is presented in this website.  Contact Jeff Johnson regarding specific data questions and comments.

Yahoo Finance link is helpful for daily market activity:  http://finance.yahoo.com/