For the year, so far, the S&P 500 is up an impressive 20.6%, which is the best year-to-date performance through September since 1997. While the third quarter ended on a positive note, there was more than enough volatility to rattle investor nerves. While the S&P 500 was up a respectable 1.7% for the quarter, the index suffered a mid-quarter drop of 6% which occurred in just a few trading days as fresh concerns about the trade negotiations with China weighed heavily on investor sentiment.
Bonds and Interest Rates
The most significant evidence of investor nervousness has been the drop in global bond yields. In the U.S., the benchmark 10-year Treasury yield dropped from a mid-July high of 2.1% to a low of 1.5% in early-September. The longer dated 30-year Treasury yield fell as well, briefly falling below 2%, which marked an all-time low. Astonishingly, in many foreign markets, an increasing number of government bonds have traded at negative yields, which guarantees that an investor will lose money on bonds held to maturity. On the other hand, with yields falling, bond investors have done quite well. The Barclays Aggregate Bond Index is up 10.3% for the past year, which is the best twelve-month performance for the index in ten years.
The other notable event in the bond market was the much feared yield curve inversion, which we discussed in greater detail in a recent blog post. The point of focus among investors is the difference between the 10-year Treasury yield and the 2-year Treasury yield. In August the 10-year yield briefly fell below the 2-year yield. Investor concern comes from the fact that an inverted yield curve has preceded every recession since the 1950’s. However, the yield curve has also inverted twice without a subsequent recession. There is also a growing belief that the recent inversion may have more to do with the overall low level of interest rates rather than the traditional causes, which are more closely tied to concerns about the economy.
Impeachment and Politics
Politics added to investor anxiety in the quarter with the Democrat led House of Representatives initiating formal impeachment proceedings for President Trump. The accusation is that Trump used his political influence to pressure the Ukrainian President to investigate the business dealings of his political rival, Joe Biden and his son. Whether or not the case against President Trump has merit, it is sure to create quite a bit of political theater. More importantly, we believe the push for impeachment has very little chance of successfully making it through the Republican led Senate.
Of greater importance to investors and business leaders has been the ongoing trade dispute between the U.S. and China. First initiated in 2018, the two countries do not appear to be any closer to a resolution. The rhetoric reached new highs in the third quarter as Presidents Trump and Xi Jinping traded rounds of escalating tariffs and restrictions, before backing off and agreeing to re-engage in negotiations. The contentious trade negotiations between the two countries have been, by far, the most significant contributor to market volatility since it began last year and was the primary reason for the volatility in the third quarter.
Economy and Expectations
Despite ongoing concern among investors, the U.S. economy remains on firm footing. The September employment report showed that unemployment has fallen to 3.5%, which is the lowest level in 50 years. U.S. GDP is positive with the most recent reading showing 2% growth, with expectations that growth will continue into next year. However, there are signs that areas of the economy are slowing. The most recent reading of the ISM Manufacturing Index fell to the lowest level in ten years.
The consensus view among economists and strategists is that a recession in the near-term will most likely be a result of the damaging effects of the trade dispute with China. The above mentioned slowdown in manufacturing is evidence that the trade conflict has begun to impact the real economy. More importantly, the uncertainty caused by these unresolved negotiations could erode confidence among business leaders making them reluctant to invest in the growth of their businesses.
Beginning with the first announcement of the trade dispute last year, the market has become very volatile. While this year’s overall gain of 20.6% has been terrific, it has mostly amounted to a reclaiming of last year’s highs following the steep selloff that occurred in the fourth quarter of 2018. In fact, the S&P 500 has only gained a total of 4.3% over the past twelve months. So if it feels like your investments haven’t made much money, it’s because the market has mostly moved sideways over the past year (and with a lot of volatility). In the meantime, earnings have continued to grow and the valuation of the S&P 500, as measured by the forward price-to-earnings ratio stands at 16.8X, which is just slightly above the long-term average of 16.2X. So even though the market has enjoyed a 10+ year bull market, stocks are not in a bubble, or even overvalued.
Given the long duration of the current bull market and recent, frequent bouts of volatility, investors have become increasingly nervous that we are approaching a tipping point. While these concerns have merit, we believe that the U.S. economy remains firm and will continue to grow for at least the next year. Under any conditions, it is important to remain well-diversified and remember that investing is a long-term endeavor.
Thank you very much for your continued confidence in our service and advice. If you would like to discuss our opinions, outlook, or your portfolio in greater detail, we would be happy to schedule a meeting or a conference call at your convenience. Lastly, don’t keep us a secret. If you know someone who would like help planning for their financial future, we will be pleased to speak with them to see if we can assist.
Horizon Wealth Advisors is a Houston based fee-only wealth management firm. Horizon is a fiduciary advisor. We specialize in helping successful individuals and families understand, organize, and manage their often complex financial situations. Horizon offers integrated financial planning and investment management services.