October 22, 2019 Letter to Clients
I hope this letter finds you doing well and enjoying the Fall season. With three quarters of the year behind us, there are several key factors to watch as we prepare for year-end and head into 2020.
The Economy in Review
The markets experienced some crosscurrents this past quarter driven by mixed messages around global growth and concerns over softer U.S. economic data. Political theater including a formal impeachment inquiry and a barrage of presidential tweets coupled with a lack of clearly articulated U.S. governmental policies, added to investor anxiety and volatility in the markets. But investor pessimism may be somewhat exaggerated and correlated more with the fear of uncertainty rather than a result of hard economic data.
The financial health of the consumer is critical to the health of the U.S. economy being that the bulk of the economy is fueled by domestic consumption and services, which remain healthy given the current 50-year historically low unemployment rate and rising wages even as manufacturing has weakened due to trade tensions. The U.S. unemployment rate dropped to 3.5% in September, its lowest level since December 1969, according to the Bureau of Labor Statistics. With continued low unemployment and a robust job market, consumers are likely to continue to spend and remain confident. Cyclical sectors of our economy, which include areas that sell discretionary items consumers can afford to buy more of during a growing economy, such as home construction and auto sales, continue to thrive with housing being the winning sector of the third quarter. These sectors are not showing signs of excesses or bubble characteristics that have historically preceded a recession; however, that does not mean the economy faces smooth sailing ahead, but rather a slow-and-steady expansion for the foreseeable future with trade tensions continuing to be the biggest downside risk to the economic forecast.
Despite a solid economic backdrop, recession concerns were once again heightened with August experiencing the second yield curve inversion this year, as the interest rates on 10-year Treasury bonds were briefly lower than those of 2-year Treasury bonds. While history shows us there is a correlation between these inversions and recessions, previous inversions have often been induced by the Federal Reserve (the Fed) aggressively tightening rates. Concerns of an imminent recession may be quelled for now as monetary policy has been more accommodative this year and other leading economic indicators used to predict a recession continue to remain healthy.
Monetary Policy
The Fed cut interest rates by a quarter point in July, which was the first rate cut in almost eleven years. The Fed also signaled their willingness to sustain the country’s longest economic expansion in history following an additional quarter percent cut in September; however, Federal Reserve Chairman, Jerome Powell, suggested that the Fed would need to move aggressively if the U.S. economy showed additional signs of weakening. Minutes from the September Fed meeting also showed that trade and the impact tariffs are having on business activity was the overriding concern amongst members.
The Tale of Trade and a Sort of Deal
For over a year, we’ve watched the trade tensions linger between the U.S., China and other countries with minimal resolution. But this isn’t new information as headlines have warned of the trade war impacts to the economy and the stock market since the 2016 presidential campaign. And while the U.S. economy has been mostly insulated from ongoing global trade uncertainty, as trade accounts for only 27% of the American economy according to World Bank figures, the recent rounds of tariffs on things people buy every day such as clothes, alcohol and electronics will have consumers feeling a more direct effect.
The markets breathed a short sigh of relief over the de-escalation in trade tensions and economy-dragging tariffs upon the announcement that the world’s two biggest economies had reached a partial deal this month. China has pledged to buy $40 billion to $50 billion in U.S. agricultural products with Trump’s agreement to suspend the tariff hike that was scheduled to take effect on October 15th. To date, the arrangement remains a verbal agreement only and has not been drafted with further details on the agreement remaining scarce. While the president has stated this is merely “Phase One” of the negotiations, it is yet to be seen if this will be the start of a larger deal with China as the U.S. is still scheduled to hike tariffs on further Chinese goods on December 15th and it does nothing to address the tariffs currently in place or any sort of enforcement procedures going forward.
Tariffs Abound
Media headlines have focused primarily on the U.S.-China trade negotiations, but other economic battles are being waged across the globe with taxation on imports being the weapon of choice. The World Trade Organization (WTO) gave the go-ahead this month to the United States to levy punitive tariffs on $7.5 billion worth of European Union (EU) goods. This was in response to the European plane maker, Airbus, receiving illegal subsidies from Britain, France, Germany and Spain, which the WTO said unfairly impacted U.S. plane makers (essentially Boeing). Although the harshest sanctions hit the countries that make the Airbus airliners, the countries affected by the announced tariffs span across Europe. Several items from European countries are being targeted, but the Scotch whisky sector is likely to see the hardest hit with 25% duties on single-malt Scotch whisky representing over half the total value of U.K. products on the tariff list according to the Scotch Whisky Association. It is likely that the EU will respond firmly should a deal not be reached as they are currently seeking WTO approval to impose tariffs on billions of dollars of U.S. exports in a parallel dispute concluding next spring over American subsidies to Boeing Aerospace Company.
We remain cautious to any trade deal as any deal reached between the U.S. and its trade partners will still need to be ratified by Congress before taking effect and given the 2020 election next year, it is likely that further progress may be stalled. However, we continue to monitor the trade negotiations and will adjust your portfolio as needed given the ongoing geopolitical uncertainty.
Tune out the Noise
In closing, we continue to believe that sound fundamentals are what matter in the long run of any economy and given the current positive fundamentals for the U.S. economy, we should continue the economic expansion, albeit at a slower pace. Concerns over global growth due to trade tensions, ongoing political discord from Washington and the direction of interest rates will continue to subject the markets to periodic swings and potential pullbacks. As we end the year, we expect the impeachment process will receive a lot of media attention, but it is not expected to have a meaningful impact to the economy or the markets. Headline noise will intensify as we move into year-end and another election year in 2020 with the main risk being political discourse harming investor confidence.
We are fortunate at LePage Financial to have access to top strategists, market analysts and economists to gain meaningful insight into the ever-changing investment and economic landscapes. Over the last 15 years, the markets have weathered natural disasters, numerous geopolitical conflicts and the deepest economic recession in the post-WWII era. I recognize that market volatility can be unnerving, however, I encourage you to not let short-term market swings distract you from your financial objectives and goals. Rest assured that as your financial advisor I am keeping a close watch over market fluctuations on your behalf. My role is to navigate crosscurrents that arise by following the well-thought-out financial plan that we have in place for you while focusing on sound fundamentals and balanced portfolios specifically designed to meet your needs. Most importantly, I am on the lookout for opportunities and any emerging long-term trends that might impact your portfolio and will be sure to communicate with you if any action points arise.
If we do not have the opportunity to speak before the end of the year, we hope that you and your family have a wonderful holiday season and find time to enjoy all that this time of year brings.
Sincerely,
Steve LePage