- U.S. stocks have been relatively stable but did hit some volatility in early October. We expect more volatility during the 4th quarter. S&P 500 companies will begin reporting third-quarter earnings soon, and the outlook already is grim: the analyst consensus is for a year-over-year decline. And, hopes for a comprehensive trade deal with China remain dim.
- Economic data has been mixed of late. Manufacturing is showing signs of weakness. Investors are watching for any signs that manufacturing weakness is starting to spill over into services or consumer-based areas of the economy.
- Global manufacturing weakness is beginning to spill over into confidence and employment channels, sending an ominous signal for world economies.
Stocks Hitting a Ceiling
While U.S. stocks emerged out of their tight range a couple weeks ago, they did not manage to surpass their July highs before falling off again in early October. Trade uncertainties remain, economic data continues to be mixed, and cloudy monetary policy and political outlooks persist.
We are in an environment that tends to favor large-cap, low volatility and momentum stocks. Larger cap companies have lower debt levels than their smaller cap brethren; are more nimble with regards to trade; and have a global presence, making it possible for them to borrow at negative rates. These fundamentals, along with the fact that a record percentage of smaller companies have soaring debt levels (as measured by the S&P 600’s debt-equity ratio of 124%), continue to support our large cap bias.
A divided economy
Economic data has been mixed of late, keeping firm the line that separates services/consumer strength from manufacturing’s weakness. The U.S. Census Bureau reported that retail sales rose in August, along with an increase in personal consumption of 4.6% in the second quarter (as per the Bureau of Economic Analysis).
In addition to still-low jobless claims and a tight labor market, the overall picture for the consumer remains fairly bright. However, strength may start to wane if trade uncertainty continues to weigh on sentiment. This may be starting to show up in consumer confidence which—as measured by The Conference Board—fell sharply in September to 125.1 from 134.2 in August.
CEO Confidence Sinks
The Conference Board’s CEO Confidence Index sank 9 points in Q3 to 34, its lowest level since Q1 2009, as pessimism spread both about current conditions and the economic outlook. The Index peaked at 68 in Q1 2017, but the so-called “Trump bump” in the aftermath of the 2016 presidential election is now snowballing toward a “Trump slump”, due to the ongoing trade war and expectations of slower global growth. As a result, more CEOs reported that they curtailed their investment last year, and a majority indicated that the trade war will have a lasting impact on their business. The drop in CEO confidence suggests continued weakness in capex through 1H 2020. It is also consistent with a decline in corporate profits.
Stocks have made limited headway over the past 20 months. Considering the potential for political headlines to change and trade tensions to escalate at any moment, we continue to believe that the risk of a correction in stock prices is high. We continue to take a defensive posture in our client portfolios (favoring large cap over small, and higher-quality bonds such as Treasuries) and will use volatility to rebalance our client portfolios to near their long-term asset allocation targets. With much uncertainty remaining with regards to trade, monetary policy, politics, and the economy, the path ahead for stocks appears no less choppy than it has been in prior months.