Market Commentary: September 2019

Looking Back: September Highlights

In contrast with August’s volatility, September was a much calmer month, which is very much at odds with historical norms.

Source: FactSet

September saw multiple global concerns that we believe played a large role in driving bearish market sentiment. Since overly pessimistic sentiment typically serves as a contrarian indicator to future price movements, this served to buoy stock prices and thrust the S&P 500 beyond August’s trading range of 2822-2945.

Source: FactSet

Bond prices indicated the market was becoming increasingly confident the Federal Reserve would continue to lower short-term rates, as necessary, even after its mid-September action. We can see this in the yield curve as middle and longer maturities have begun to rise while shorter maturities continue to fall, thus reducing the curve’s inversion.

Source: FactSet

Other September Occurrences

• International equity markets bounced back after months of weakness. While one month does not make a trend, this is something to keep an eye on. In addition, global purchasing managers’ indexes (PMIs) have begun to show signs of declining at a slower rate, which may be the first sign of a market bottom.
• The domestic PMI came in under 50 for the first time in three years, further confirming potential economic weakness is looming. Since capital markets typically lead economies, such weakness is likely priced in at these levels. In fact, our estimates show if earnings were to remain flat in 2020, the market would experience a decline of ~10%-15% at current valuations—a sign of typical market noise.
• The Trump administration delayed increasing tariffs on $250 billion worth of Chinese goods in “a gesture of good will” ahead of the People’s Republic of China celebrating its 70th anniversary on October 1. Given their individual economic ambitions, the U.S. and China are going to have a difficult time finding common ground. As such, despite the mid-October talks, we believe the likelihood of a trade deal remains low. Our position is that the effects of continued tariffs (at this point) will lead to slowing growth, but not recession.
• Jobs and wage data continue to defy historical precedent in a “slowing” economy, as both remain strong. In advance of sustained economic weakness, we would expect to see increased unemployment and stalled wage growth. Though there was some weakness in employment numbers, that was largely the result of the General Motors strike. We believe the robust jobs number is what prevented the Fed from lowering the federal funds rate by more than 25 basis points (bps); Fed governors are loathe to ease too aggressively in the face of a potentially inflation-producing labor market.
• Two Saudi Arabian oil facilities were decimated in a drone strike, forcing the world’s top oil exporter to shut down half of its production operations. Although Iran is the main suspect, the source has yet to be officially determined. The attacks triggered the largest spike in crude prices in decades, but they stabilized in a matter of days due to a faster-than-expected recovery. We believe the biggest takeaways from this event are:
• Mideast tensions remain palpable and subject to spontaneous combustion at any moment.
• Oil price action remains bearish with prices more likely to decline than rise from here.
• Impeachment talk intensified over President Trump’s phone call with his Ukrainian counterpart. While the chances of a Senate conviction are low, how this plays out should not be dismissed for its potential effects on policy if it affects the outcome of the 2020 election. To us, this is where the rubber meets the road; policy is more of an issue than politics, and any impact on policy could have fallout on the economy and the markets. However, we do not believe politics, in and of themselves, are something to be concerned about.
• Skepticism abounds regarding the WeWork initial public offering (IPO). While a real estate company with a subleasing business plan is not a microcosm of the U.S. economy, it’s unclear what WeWork’s struggles may mean for private market valuations and the prospects for the public market moving forward. Typically, IPOs are treated optimistically in the late stages of a bull market due to the accompanying euphoria.

What We’re Watching

The Fed is meeting October 29-30. The Fed does not characteristically move rates outside of its main quarterly meeting schedule (i.e., March, June, September, December). However, it took action in the July off-quarter meeting, and we expect further action in October in the form of another cut of 25 bps. While a 50 bps cut is not completely off the table, we would be surprised if it were to occur given the aforementioned strength of the labor market. We will look to the Fed’s language to determine its outlook and the potential for further cuts in 2019. At this point, we continue to expect another cut in December.

What’s in Store for Capital Markets?

• The S&P 500 spent August bouncing between 2822 and 2945, finally breaking out of this range in early September. Our new range of 2822-3028 reflects seasonal weakness which typically resolves itself in late October, with the November-December period being the strongest of the year. So, we expect this range to dissolve over the next few weeks as markets navigate the trade, political, and economic headlines.
• Investor sentiment remains fragile. This sentiment, combined with compelling valuations, should be a tailwind for equity prices once seasonality runs its course in late October.
• We expect bond yields to remain rangebound awaiting confirmation that the Federal Reserve is hearing the bond market’s message loud and clear. After the Fed takes sufficient action (likely after either December’s projected rate hike or another cut early in 2020), we would expect rates to begin a slow rise. However, we do not look for rates to rise substantively anytime soon. This should keep both a floor and a lid on fixed income prices in the near-term.