U.S. stocks climbed higher last week, finishing the volatile month of August on a high note. Behind the rally was optimism that further escalation in the trade spat between the U.S. and China will be avoided based on vague conciliatory comments from both sides. Economic data also helped after showing that consumer spending, which accounts for 70% of economic growth, rose by 4.7% in the second quarter, the strongest gain in four years. In another twist on the Brexit saga, odds of the U.K. leaving the European Union without an agreement increased last week after the prime minister announced he would be suspending Parliament before the October 31 Brexit deadline. Despite all the geopolitical uncertainties, it's the solid consumer fundamentals, still-rising corporate profits, and accommodative monetary policy that can help extend the economic expansion, in our view.
Stuck in Neutral -- What's Next?
Last week brought the end of August, a volatile month during which stocks swung widely on frequent trade news between China and the U.S. -- bouncing between progress on negotiations and the escalation of tariffs. The S&P 500 is up a solid 17% in 2019, but down 3.5% from the recent high and at about the same level as it was this time last year1. That said, the market hasn't sat still during that time. The sharp sell-off last December was followed by a strong rally to new highs through much of 2019, before losing some traction over the past month. Similarly, as impressive as this bull market has been over the last 10 years, the ride has not always been smooth, with several bumps along the way and extended periods of market volatility, namely in '11-'12 and in '15-'16. Stocks finished August on a high note, but recession fears are still lingering. To frame the current conditions, it's worth examining the opposing forces that dominate the current narrative and checking for engine warning lights that signal potential problems concerning the bull market's longevity.
Trade and global uncertainties hitting the brakes – One of the most prominent market concerns is the ongoing escalation of trade tensions between the U.S. and China. So far, most of the damage from tariffs has shown up in the form of indirect effects, like deterioration in business confidence and depressed business investment. World trade has not collapsed, as supply chains reshuffle to soften the blow from higher tariffs, but trade volumes globally are declining at the fastest pace since 2009 (-1.4% over the last year for the month of June)2.? Most of the weakness has been concentrated in the manufacturing sector, with the Purchasing Managers Index now showing contraction of the manufacturing economy in the eurozone, China, and, according to a preliminary August reading, the U.S. We don't think trade alone will trigger a recession because the U.S. economy is not overly export-reliant (exports represent about 13% of U.S. GDP), as it's far more dependent upon the services component of the economy versus goods production3. The ultimate timeframe and outcome of the trade situation remains quite uncertain at this stage, but our view is that de-escalation or an eventual deal will be achieved because of the mutual economic interest in finding a solution. This is likely to take time, however, and, in the meantime, escalating trade tensions could continue to pump the brakes on the stock market.
Consumption revving into high gear… - Consumer spending remains the economy's bright spot. A fresh read of consumer confidence last week showed that consumers’ assessment of current conditions is now at its highest level in almost 19 years. Despite heightened uncertainties, consumers have remained confident and are willing to spend, as evidenced by the strong July retail sales data, solid earnings from several bellwether retailers, and the upwardly revised consumption-growth figure for the second quarter to a very strong 4.7% annualized growth. This strength ties back to the job market, which is arguably firing on all cylinders, with unemployment near 50-year lows and rising wages. The proportion of the responders to the consumer confidence survey reporting jobs as "plentiful" reached the highest level since 2000 this month at 51.2% from a low of 3.1% at the height of the financial crisis4.
…but can it last? Assuming trade issues remain unresolved for an extended period, it is not hard to envision some deterioration or slowdown in the labor market. That said, in our view, household finances are in sufficiently good shape to keep consumer spending rising, buffering a slowdown in economic growth. Household savings as a percent of disposable income stands at 7.7%, higher than the 20-year average (6%) and 30-year average (6.5%). Households have greatly repaired their balance sheets and deleveraged since the financials crisis, with debt as a percent of disposable income declining to less than 100% from 133% at the end of 20073. At the same time rates have dropped near record lows, which reduces the cost of serving mortgages and auto loans. Therefore, consumers have the capacity to maintain spending via rising wages, elevated savings and/or new loans.
Buckle up & stay the course – Beyond the noise of the daily trade headlines, a look under the hood reveals some useful takeaways:
We acknowledge that there are credible threats to the bull market's longevity, but we think recession fears are overblown. Outside of the inverted yield curve, which we have discussed extensively, several other indicators, including the leading economic index, business surveys, weekly jobless claims, and credit spreads, that typically lead recessions are not yet glowing red across the dashboard, in our opinion. The consumer -- the engine of the U.S. economy -- is in good shape, corporate profits are still growing, stock valuations appear fair, monetary policy is accommodative, and interest rates are low. In our view, pullbacks and periods of volatility have proved to be buying opportunities in the past when fundamentals were reasonably solid as they appear today. In challenging and uncertain conditions we believe an appropriate longer-term perspective and a well diversified portfolio with the proper mix of stocks and bonds can help investors hug the road and weather the volatility.
Angelo Kourkafas, CFA
Investment Strategy Analyst
Sources: 1. Bloomberg, S&P 500 price return, 2. CPB Netherlands Bureau for Economic Policy Analysis, 3. U.S. Bureau of Economic Analysis, 4. The Conference Board, 5. Bloomberg, S&P 500 total returns
|Dow Jones Industrial Average||26,403||3.0%||13.2%|
|S&P 500 Index||2,926||2.8%||16.7%|
|10-yr Treasury Yield||1.50%||-0.03%||-1.18%|
Source: Bloomberg, 08/30/19. *5-day performance ending Thursday. Bonds represented by the iShares Core U.S. Aggregate Bond ETF. Past performance does not guarantee future results.
The Week Ahead
The Weekly Market Update is published every Friday, after U.S. markets close.
The Dow Jones Indexes are proprietary to and distributed by Dow Jones & Company, Inc. and have been licensed for use.
All content of the Dow Jones Indexes ? 2017 is proprietary to Dow Jones & Company, Inc.
The Dow Jones, S&P 500 and Barclays Aggregate Bond Indexes are unmanaged and are not meant to depict an actual investment.
Past performance does not guarantee future results.
Diversification does not guarantee a profit or protect against loss.
Investors should understand the risks involved of owning investments, including interest rate risk, credit risk and market risk. The value of investments fluctuates and investors can lose some or all of their principal.
Special risks are inherent to international investing, including those related to currency fluctuations and foreign political and economic events.
This information is approved for use with the public.
It is intended for informational purposes only.
It is believed to be reliable, but its accuracy and completeness are not guaranteed.
Get instant quotes for your favorite companies and mutual funds.