After a challenging summer, equities rallied into September
resulting in mild gains for the Canadian and US equity markets. In response to a continued slowdown in
economic growth, US and European central banks lowered interest rates. The lower rates led to a solid quarter for
Canadian bonds.
An inverted yield curve, negative interest rates and fears
of a recession contributed to stock volatility.
The US yield curve briefly inverted (short term rates are higher than
long term rates) during the third quarter.
Inverted yield curves typically precede recessions by six to nine
months. One can argue that this indicator is not as relevant today as over $15
trillion of sovereign bonds currently trade with negative interest rates. While
we do not typically subscribe to the “this time is different” camp, we
acknowledge that the yield curve barely inverted for a few days so maybe we should
focus on other indicators.
The ISM Manufacturing Index dipped below 50 indicating that
the Manufacturing economy is weak. Although this is not positive, manufacturing
accounts for a small percentage of the US economy. The US – China trade war is also generating
business uncertainty contributing to lower investment in the US and slower
economic growth in China.
On the positive side, the US consumer remains healthy. Consumer confidence declined slightly from
elevated levels and consumer spending has remained robust. The tightening cycle
of the last few years is over as most central banks are easing. Employers are
continuing to hire, especially when they can find people who have the skills to
fill open vacancies.
When considering the future direction of equity markets,
investors are looking at a muddled picture. There appears to be a tug of war between
slowing growth, a short-lived inverted yield curve and recession fears on one
side with fair valuations and central banks easing on the other side. We currently do not envision a recession, but
we will continue to monitor the data to evaluate if a change in strategy is
warranted.
These mixed signals point to muted stock returns with
increased volatility. There are still opportunities to make money but making
significant returns will be challenging.
To be clear, we do not envision a recession or a significant drop in the
market, but also can make a case where stock market returns will be more subdued
than they have been over the last 10 years.
The stock market remains near record
levels which is partly related to historically low interest rates. We are still
positive on the outlook for stocks, even though valuations can best be
described as full, being neither cheap nor hideously expensive. We continue to believe that stocks are more
attractive than bonds even if our equities outlook is increasingly subdued.
Due to slowing earnings growth and the
run up in prices since the beginning of the year, stocks are vulnerable to a pull
back. We are getting increasingly conservative with respect to the stocks we
hold for clients and are gravitating to companies that are not particularly
economically sensitive. If anything, we
prefer stocks where performance will be a function of something other than the
economy. We prefer catalysts that
involve a turnaround, a restructuring or being dependent on a cycle that is
independent from the economy. We have also trimmed positions that have
performed particularly well leading to cash being at more elevated levels. We will redeploy cash into stocks if better
opportunities are presented.
As always, we welcome your thoughts and comments.
