Thanksgiving is next week and as we all know, Christmas follows close behind. I know that people say that times flies faster as you get older, but somehow this year has slipped past very quickly. Before you know it, we will be reading the financial predictions for next year and the results from 2019 will already be behind us. Time has flown by.
2019 has been a good year for the financial markets and investor portfolios have done well. As I am writing this note, equity markets in the US are flirting with all-time highs there is talk of another “Santa Claus rally” in December. Interest rates are very low, employment is strong, and all seems well. But only a few weeks ago we were worrying out loud that the next recession was imminent, and the big correction was around the corner. People were a little nervous. That fear has faded, however, in the euphoria of a strong stock market and low interest rates. It’s hard to argue with the numbers.
To be sure, there are concerns. The bull market we have benefitted from has run for over 10 years, and by any measure it is the longest bull run in history. Since 2009 the market has appreciated over 300% from the lows of the 2008 mortgage crisis. The closest we’ve seen to that kind of appreciation was a 7-year run right after WWII, when there was a 235% gain.
We all realize the stock market cannot go up forever, and many analysts are calling the top. But somehow the ticker keeps going higher, shrugging off trade concerns, political infighting, and growing government deficits.
Markets respond to many factors and it would be easy to invest profitably if market movements were consistently logical, but they are not. While overall economic growth and individual company’s profitability will always be the main driver of market direction, there many factors that make up the market equation. Algorithmic trading, once a quirky side story in the markets, is now both the leading provider of liquidity and cause of increased market volatility. Government policy, taxes, central bank policy, trade, and large capital flows all create momentum and direction that today’s investors try to navigate by building complex computer models to predict and react to news and data.
But perhaps the least quantifiable but most pervasive influence on the current rally has been investor sentiment. Investors always have a choice between the half-full or the half-empty glass, and for the last 10 years have chosen to see the positive. There have been bumps in the road and corrections, but overall the 10-year bull market has been fueled by optimism about the present and hope for the future. Technology has provided a catalyst for this optimism, with the economy becoming more efficient, providing new areas of employment and innovation. Cheap energy and low interest rates have made capital available for business expansion and growth.
As we make our way towards the end of the year, it would be useful to review the themes that have formed the investment narrative. They are familiar topics, but sometimes it’s easy to forget how these themes came about and how the narrative can change.
The trade war with China started as a negotiation to improve an unequal trade situation. Trading under rules originally intended to protect China as a third world economy, the rapid growth of the Chinese economy has made China a world economic power and created the need for those rules to be recalibrated.
For years, protected Chinese markets were restricted to US products while at the same time China’s cheap labor attracted American manufacturing. American products made in China were imported back into the US. But US companies which benefited from lower manufacturing costs also found their technology secrets compromised as US technology was stolen and copied. Meanwhile plants closed in the US and jobs disappeared.
What started as a quick negotiation to rectify this decades old problem swiftly escalated as both sides sought to justify their position. Tariffs were imposed by both sides on a wide variety of goods, including agricultural products and manufactured items. Both sides sought to gain an advantage in a spiral of failed negotiations that soon began to hurt both economies.
In early August there appeared to be a breakthrough when China agreed to increase purchases of US food products and the US agreed to ease tariffs, but China backed away from an agreement and the markets quickly recalibrated. The Trade War has become an issue for everyone who has been touched by tariffs and the uncertainty of a deal ever being done. There have been ominous predictions that failure to find agreement might lead to global recession.
The steady stream of commentary from the White House, the trade negotiation teams, and the Chinese has caused the market to react to each turn in the negotiations. The issues that remain are still the same as those that ignited the conflict; Chinese purchases of US agricultural goods, protection for US technology and intellectual property, tariffs, and access to China for US goods and services.
The most recent announcements have an agreement moving ahead in two stages. The first phase would include Chinese purchases of US farm products and provisions to deter currency manipulation and theft of intellectual property and patents. A schedule of reduced tariffs and US access to Chinese markets could form part of the second phase.
While the Chinese trade war has occupied the headlines, other trade agreements have been negotiated by the US with Japan, Korea (KORUS), and nearer to home, Mexico and Canada (USMCA). These agreements are expected to be useful in dictating terms designed to strengthen US manufacturing and the US trade balance of manufactured goods.
During the last three years, politics has influenced our lives as never before. In a media world where news is mostly unfiltered, the US political discussion has been partisan and uncompromising. Most would agree that the polarization of politics has been destructive to our society and made it increasingly difficult to find accommodation and common purpose, particularly in government. It is important that our political institutions find ways to overcome division and move forward on the practical challenges we face.
The 2020 presidential election campaign has already focused attention on insurance and healthcare, and key part of the economy. The US healthcare system, already under intense scrutiny from the opioid crisis, has been criticized for the high cost of hospitalization, treatment, and drugs, while lacking quality healthcare for those who need it most. From a financial perspective, this important sector has become both a danger and an opportunity, as seemingly strong investment thesis can crumble or soar under political announcements. Everyone agrees reform is needed, but finding a solution that provides investment incentive, reasonable cost, and access remains elusive.
Both parties have expressed interest in working together to repair and upgrade the infrastructure in our country. This infrastructure includes not only roads and bridges, which are in need of major expenditure, but also ports and airports.
Lastly, technology has been, and continues to be the prime wealth creation engine of our modern economy. The largest companies in the world grew from small tech start-ups to dominant or economy and even our culture. Firms like Apple, Amazon, Google, and Facebook have all become household names by finding ways to provide technology that has changed the way we live. Smart phones, on-line shopping, internet search engines, and social media are now fundamental to how we live, and particularly to how we do business. Concerns over the pervasive control that these large firms, and others, have on our lives through the data these collect from us and about us has led to calls for restrictions and potentially break ups of the large firms. The misuse of technology for political gain has created a hot button in an industry that has grown from nothing in 10 years. Additionally, the arrival of 5G communications, while presenting an opportunity to take the US to the next level in technology, is clouded with security concerns over Chinese manufactured equipment.
Infrastructure, both physical and technological, is the underpinning of our economy. and continued investment is both necessary and long overdue. Investment in the space has been lucrative, but investors are now more careful than ever.
By now everyone is familiar with the term Brexit, or the Briton’s exit from the European Union. The beginnings of this political breakup came from a referendum three years ago following a Conservative Party debate about the merits of the European Union. A leadership contest in the majority party spun into a national poll on whether to stay or leave the EU. The “leavers” won, but the actual implementation of the referendum has dragged on as a reluctant Parliament has failed to agree on the mechanics of England’s departure.
Boris Johnson, the British Prime minister, came to power on the promise to implement Brexit and no longer delay Britain’s departure from Europe. He has moved the Brexit drama into a new phase, promising a tough stand with the European Union and the final implementation of Brexit, as dictated by the national referendum. However, the latest October 31 Brexit deadline came and went on with continued parliamentary maneuvering on both sides of the political question.
The Prime Minister sought to break the deadlock by calling an early parliamentary election, essentially forcing each member of Parliament to seek reelection on a single issue. His calculation is that a strong conservative showing in the election will provide the government with the necessary votes to negotiate a favorable Brexit deal with the EU, or failing that, a “hard Brexit” or no-deal departure. Labor MP’s are hoping their influence will grow through coalitions and power sharing following the early election and could even result in a new referendum designed to overturn Brexit. Politics in Britain has never been so lively, but the prospect of an eventual departure from the EU seems inevitable given the current political winds.
After 10 years of bull markets, US economic growth should be expected to cool at some point. This has indeed happened in the last quarter, although employment and corporate profits remain strong. Fueling the economy is the domestic consumer, backed by strong employment and low taxes. Wage growth is steady, with near full employment leading employers to raise wages to keep and find good employees.
Corporate profits continue to exceed analyst’s expectations. During the last round of quarterly corporate earnings reports, more than 75% of the S&P 500 beat projections, slightly above the 5-year average of 72%. This strength is highlighted when compared to the rest of the world, where trade tariffs have been felt from Europe to Asia, and growth has suffered. Although US profit growth has slowed to 2% from last year’s 3%, continued low inflation magnifies the positive effects.
The latest round of interest rate cuts by the Federal Reserve have brought rates to the lowest levels in history with assurances from the Fed that policy will remain accommodative. The Fed believes the economy remains strong and the risks of a near term recession remain low.
US employment measures have shown a string of job increases in each of the last 109 months, representing the longest stretch of job creation since 1939. Although job creation has slowed from last year, an average of 167,000 new jobs have been created each month of this year. Unemployment now stands at 3.6%, with participation in the economy of 25 to 54 year-old workers at an all-time high.
As the year concludes there are many positive signs. At Calyx we remain both vigilant and opportunistic, always looking for opportunities. In the stock market many securities are over-valued by historical standards, so we are keeping our risk related stop orders close. We are invested in a strategic mix of growth, dividend and fixed income, content to take consistent returns without too much exposure.
Happy Thanksgiving to you and your families!
Ed, Branson and Claudia
At Calyx, we help families protect and manage their financial resources. We are a financial advisor and investment manager that partners with our clients to administer their financial affairs with personal attention and active risk management. Calyx is also advisor to charitable trusts and endowments, working with committees of faith-based organizations to preserve their legacy while providing operating income. We are sensitive to the investment needs of these clients while working within the guidelines they have established to reflect their principles.