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Weekly Market Review

04 September 2019

Clint McGarvin, CFA® | Portfolio Manager

Week Ending August 30, 2019

The U.S.

U.S. stocks jumped last week on hopes that an agreement on a trade deal between the U.S. and China can be reached prior to the point of no return on a recession. Large caps were up about 2.8% while small caps increased a little less than 2.5%.

With last weeks return, U.S. equities have recovered just over 50% of the decline caused by the escalation of the trade war. While businesses pulled back in the second quarter, consumers continue to spend freely. The first revision for second-quarter Gross Domestic Product (GDP) showed that the business segment of the economy contracted 6.1% while the consumer segment expanded by 4.7%. This growth in Personal Consumption Expenditures (PCE) is the fastest rate of growth in 4.5 years.[i] Consumers shined again in July as  PCE increased 0.6% month-over-month and are up 7% over the past 12-months.[ii] Despite the increase in tariffs, inflation remains muted as the PCE Price Index increased by 0.2% month-over-month in July and has increased by 1.4% the past year. Core inflation, which excludes food and energy, is up 1.6% over the last 12-months, which suggests the Fed has significant flexibility to cut rates at their September 18 meeting. The Fed fund futures probability as of this article is forecasting a 100% chance of a cut with 97.3% probability of a 25-basis point reduction and a 2.7% chance of a 50-basis point reduction [iii]

International

International equities were also positive last week on hopes of a trade deal with developed stocks rising about 0.9% and emerging stocks up a little more than 1.1%.

Global manufacturing sectors improved slightly in August with Chinese manufacturing expanding for the first time in five months while Eurozone manufacturing, which is still contracting, improved from 46.5 in July to 47.0 in August.[iv] Germany continues to be the weak link in Europe as manufacturing contracted again with the index hitting 43.5. Germany is the largest manufacturing country in Europe, therefore, indicating the overall health of European manufacturing is weak.[v] The expansion in China was on the back of inventory growth as exports continued to decline, but finished goods rose for the first time this year.[vi]

Fixed Income

Bonds moved in the same direction as stocks last week with high quality bonds rising about 0.2% and long-dated Treasuries up about 0.8%. Long-term Treasuries and REITs are the best performing asset classes year-to-date, up approximately 22.8% and 26.1%, respectively.

Fixed income markets are flashing a “recession is coming” message as Treasury yields remain inverted across most of the yield curve, including the Fed funds target rate at 30-years.[vii] The 30-year Treasury hit an all-time low last week of 1.90% intraday but has since recovered slightly to close the week at 1.96%. The 2-year and 10-year both closed the week at 1.50%.

Summary

A plentitude of signals indicates a recession may be on the horizon. Some signs include the global slowdown in manufacturing, the inverted yield curve (U.S.),  and slowing or declining corporate profit growth and spending (U.S.). Also, the labor market, which has given consumers the confidence to continue spending, is showing signs of weakening as the Three Month Moving average of nonfarm payrolls have declined four of the last six months. Despite these signs, the U.S. consumer continues to spend and even dipped into savings to spend more in July.

The manufacturing indexes in Europe and China improved slightly in August (though again Europe continues to contract), and in the U.S. core durable goods orders, a proxy for business spending, increased 0.4% in July.[viii] Unfortunately, the negative side of the improvement in the manufacturing data is that China’s manufacturing sector improvement is based on finished goods rather than an increase in end-user demand. The slight improvement in the Eurozone left the manufacturing sector in contraction territory still, and there has been no improvement in end-user demand. The improvement in the U.S. core durable goods orders is not as positive as the growth would indicate given the durable goods orders ex-transportation was down 0.4%, so the very volatile aircraft orders pushed orders higher rather than a true growth in business spending.

The signs of a recession are present and real, but that does not mean a recession is inevitable. The Fed can and is likely to help with additional rate cuts. The labor markets can continue to expand, adding more fuel to consumer spending. On top of this, government spending has been adding to GDP and end-user demand, which is likely to continue given the election next year, incumbent politicians will increase spending in an effort to avoid a recession before the election to increase chances of being reelected.


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[i] Bureau of Economic Analysis (BEA) (2019), GDP and Personal Income Data. Retiieved from https://apps.bea.gov/iTable/iTable.cfm?reqid=19&step=2#reqid=19&step=2&isuri=1&1921=survey and https://apps.bea.gov/iTable/iTable.cfm?reqid=19&step=2#reqid=19&step=2&isuri=1&1921=survey
[ii] Bureau of Economic Analysis (BEA) (2019), Personal Income and Outlays, July 2019. Retrieved from https://www.bea.gov/system/files/2019-08/pi0719.pdf
[iii] CME Group (2019) CME FedWatch Tool. Retrieved from https://www.cmegroup.com/trading/interest-rates/countdown-to-fomc.html/
[iv] PMI by IHS Markit (2019), IHS Markit Eurozone Manufacturing PMI® – final data. Retrieved from https://www.markiteconomics.com/Public/Home/PressRelease/b1d84b588d1648559f86c40a9a413778
[v] PMI by IHS Markit (2019), IHS Markit / BME Germany Manufacturing PMI. Retrieved from https://www.markiteconomics.com/Public/Home/PressRelease/915b5392fc37412bb5fbd02aaa7430d5
[vi] Markit Economics (2019), Caixin China General Manufacturing PMI. Retrieved from https://www.markiteconomics.com/Public/Home/PressRelease/9dfddef276024a08b0e3cb49e1a5c529
[vii] U.S. Department of the Treasury (2019), Daily Treasury Yield Curve Rates. Retrieved from https://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=yield
[viii] U.S. Census Bureau (2019), Monthly Advance Report on Manufacturers’ Shipments, Inventories and Orders July 2019. Retrieved from https://www.census.gov/manufacturing/m3/adv/pdf/durgd.pdf
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