Stock and bond markets continue to climb despite uncertain global economic prospects. Growing trade tensions, Brexit worries, inverted yield curves, and fading US tax cut benefits weigh on both market sentiment and fundamentals. The US economy continues to outperform other developed nations. However, the US-China trade dispute clouds the overall global economic picture. High level trade talks between the two countries planned for October will be closely watched. The Federal Reserve Bank cut short-term interest rates twice in 3Q by one-half percentage point in aggregate to support the economy. Central banks around the globe also reduced interest rates to stimulate their economies. Following is a closer look at what is happening in the markets and economy.
The US stock market expansion crossed the 3,453 day mark last August 21st, making it the longest bull market on record. Since bottoming on March 9, 2009, the S&P 500 has risen more than 440%, including price appreciation and dividend reinvestment. The S&P 500 Index hit a record high on July 26th before dropping into a volatile August. Investor concerns rose over the ongoing trade dispute and inverted yield curve. The market regained its footing in September, but fell short of new highs by quarter end. At September 30th, US stocks were up 1.7% for the quarter and an impressive 20.6% year-to-date. International stock performance trailed the US, falling 1.0% in 3Q and up 13.3% year-to-date.
Bond diversification benefits were on full display in 3Q. While stocks declined in August, bonds rallied and provided investors a safe haven from market volatility. Bond values have been fueled by declining interest rates, recession worries, and muted inflation expectations. The 10-year US Treasury yield has fallen a full percentage point since the year began. In August, the bond yield curve inverted as short-term interest rates moved above long-term rates. While some view a yield curve inversion as an early recession indicator, history shows that the yield curve is often a poor predictor of economic slowdowns. US taxable bonds were up 2.3% in 3Q and 8.5% for the year. US tax-free municipal bonds rose 0.8% last quarter and 4.7% year-to-date.
US GDP growth rose 2.0% in 2Q, driven by consumer and government spending. Despite trailing the prior quarter’s 3.1% growth, the current rate tracks closely to the Fed’s 2.2% growth projection for the year. Fresh data shows that consumers recently pulled back on spending and businesses cut back on investment. A falloff in consumer spending is troubling since consumers account for 70% of demand in the US economy. The US-China trade conflict creates uncertainty for consumers, business, and investors. Resolving this dispute is critical to continued economic growth at home and abroad.
The US labor market remains healthy with unemployment remaining steady at 3.7% so far this quarter. Just 96,000 new private sector jobs were added in August. However, wage growth increased 3.2% over the past twelve months, rising faster than consumer prices. The proportion of employed Americans aged 25 to 54 reached 80% in August, the best showing in the 10+ year current economic expansion.
2Q earnings growth slowed to just 3.2% year-over-year, following a robust 20%+ pace in 2018. This falloff reflects the fading tax reform stimulus, a stronger US dollar, slower global growth, and lower oil prices compared to a year earlier. Almost 74% of S&P 500 companies reported earnings above analyst expectations, well above the historical long-term average but slightly lower than the previous four quarters. Corporate revenues increased by 4.6% year-over-year in the second quarter.
In July, the Fed cut short-term rates for the first time in 11 years and announced the end of their balance sheet reduction program. These actions were followed by another Fed rate cut in September, bringing short-term interest rates down 0.50% in total. Both cuts were attributed to slowing economic growth, unresolved trade tensions, and low inflation. Dovish monetary action has been enacted overseas as well. More than 30 central banks around the world have cut interest rates this year.
Following their September meeting, the Fed’s 2019 inflation projections stood at 1.8% with a long-term projection of 2.5%.The Fed’s target inflation rate is 2% annually. Their inability to reach the 2% target prompted the two recent rate cuts. In August, the Personal Consumption Expenditure Price Index was only at 1.4%.
The final months of 2019 may see increased market volatility as the US and China attempt to reach a trade deal. The US economy remains healthy as evidenced by steady growth, strong employment, low interest rates, and low inflation. Recession is not imminent, but risks are rising. These risks can be attributed in part to the ongoing tit-for-tat trade war between the US and China. A resolution is in the best economic and political interests of both sides, particularly with US elections just one year away. We advise clients to step back, take a breath, and maintain a long-term view of their portfolio. The larger picture is generally more encouraging than the daily snapshots. We advocate a long-term perspective, focus on discipline, and investment diversification as the best strategy for achieving your financial goals.