Quarterly Market Commentary – Q3 2019

U.S. Stocks:

The U.S stock market continued to set new records, as the S&P 500 Index increased 1.7% in Q3 (+ 20.6% YTD). The Information Technology sector (up 31.4% YTD) remains the best performer so far this year, but Q3 saw a rotation into more defensive sectors such as Real Estate ($2.1 billion inflows) and Consumer Staples ($1.6 billion inflows). Utilities were the top performing sector, gaining 7.71% for the quarter. The notorious FAANG stocks (Facebook, Apple, Amazon, Netflix, Google) fell out of favor, underperforming the overall market throughout Q3. IPOs set a record, raising $23.3 billion so far this year, which trumps the previous record set in 2000 at the height of the tech bubble. Many so-called unicorn companies rushed to IPO such as Uber, Lyft, Slack, and Peloton.

Investors also sought the safety of long-term bonds with the Bloomberg Barclays 10+ Yr. rallying 6.6% in Q3 and 20.9% YTD. The overall rotation into safer assets is a result of a slowing global economy and uncertainty regarding trade negotiations between the United States and China. The stock market suffered its worst day of the year on August 14th with the Dow falling 800 points (3%), due to the 10-year treasury yield falling below the 2-year treasury yield. This phenomenon, known as an inverted yield curve, generally occurs when investors are worried about the near-term and they pile into safer long-term investments. The Federal Reserve cut interest rates twice in Q3, in an effort to boost the economy.

Notable & Interesting Company Specific Headlines from Q2:

  • Tobacco giants Altria and Philip Morris called off their $200 billion mega merger, as the FDA considers banning flavored e-cigarettes. Thus far there have been at least 1,000 reported cases of vaping related illnesses and 18 deaths. By merging with Philip Morris, Altria hoped to make Juul, the wildly popular e-cigarette, available outside of the United States. Even as Juul faces an existential crisis, Altria and Philip Morris are in the process of rolling out IQOS, a new product that heats up tobacco instead of vaporizing a liquid.
  • Shared workspace unicorn WeWork ended up calling off its IPO after its valuation was cut from an initial $47 billion down to $10 billion. WeWork lost $1.9 billion in 2018 alone ($219,000 every hour). To top it all off, the company’s famed Founder and CEO, Adam Neumann, was forced to resign from the company shortly after the failed IPO.
  • General Motors has lost an estimated $660 million in revenue since September 13th due to an ongoing strike involving 46,000 GM employees, represented by the United Auto Workers Union. The workers are demanding better pay, healthcare, and retirement benefits. Anderson Economic Group estimates that if the strikes continue, GM could lose as much as $90 million a day.
U.S. Macro News:

The economic cycle entered its 11th year of expansion in July, but it is still not displaying late-cycle characteristics such as high inflation or elevated interest rates. According to Federal Reserve Chairman Jerome Powell, “overall the economy is in a good place and long-term challenges facing the economy include low growth, low inflation, and low interest rates.” 2nd Quarter GDP growth decelerated to 2%, and the Fed expects GDP to further decelerate to 1.8% by Q4. The Fed is attempting to combat a slowing U.S. economy by cutting interest rates twice in Q3 to a range of 1.75% – 2.00%.

The September Manufacturing PMI headline dipped further into contraction territory, coming in at 47.80 compared to 49.1 in August (sub 50 number indicates negative growth). Inventory levels accounted for the biggest decline, as firms have been increasingly citing softer business conditions due to trade concerns. According to Bloomberg, an economic recession is not necessarily implied by the manufacturing PMI index until dipping below 44.

The September Services PMI showed greater hiring caution as businesses are increasingly cautious about enlarging payrolls amid elevated outlook risks. This suggests that service sector confidence and employment are not immune to the impact of the trade war. Despite some weaknesses, Services PMI remained in expansion (52.6).

The September jobs report came in below expectations, but overall relatively strong. Non-Farm payrolls rose 136,000 vs. an estimated 145,000. Unemployment is down to 3.5%, a level not seen since 1969. Wage growth decelerated, but still managed to grow 2.9% YoY, outpacing inflation by 0.5%. Overall, household paychecks continue to grow, increasing over 4% YoY (Source: Refinitive data). In general, rising paychecks tend to support elevated consumption levels.

Oil News:

The U.S. benchmark crude (WTI) oil price spiked to $62.90 per barrel on September 16th due to a devastating drone attack on Saudi Arabian oil fields. Twenty-five drones and missiles were used in the attack that forced Saudi Arabia to shut down half of its oil production. The attack took 5.7 million barrels per day of crude oil production off the market (the total world production is 80 million barrels per day). Saudi Arabia suspects that the attacks were carried out by Iran, elevating tensions between the two countries. Saudi-Arabia managed to restore most of the lost oil production, which helped push oil prices back down to $53.70 per barrel by the end of Q3.

European Union:

The Euro-area GDP grew by a modest 0.2% in Q2, vs. 0.4% in Q1. Europe continues to face uncertainty over U.S. protectionist policy, a hard Brexit, and risks to China’s economy. Much of the euro-area weakness can be attributed to Germany, which experienced GDP contraction of 0.1% in Q2. Germany’s industrial production has taken a hit from elevated trade policy uncertainty and a turn in the global investment cycle. European Central Bank President Mario Draghi announced drastic measures to boost the European economy. The ECB plans to continue asset purchases of $20 bn per month for as long as necessary or until the inflation rate reaches the 2% target (current inflation rate at 0.9%).

Trade War:

The tit-for-tat trade war between the United States and China continued to develop throughout Q3. On August 1st President Trump announced 10% tariffs on an additional $300 billion of Chinese goods. China quickly retaliated by imposing 5%-10% tariffs on $75 billion American goods. In response, President Trump announced that he would raise tariffs from 10% to 15% and ordered American businesses to immediately start looking for an alternative to China. Despite rising tensions, both sides agreed to resume talks. Markets are hoping for a possible trade deal in the second week of October.

As a reminder, here is what’s at stake if a truce is not achieved by the October meeting:

  • Oct 15th: The U.S. is scheduled to raise its 25% tariff on $250 billion in Chinese goods to 30%.
  • Mid- November: President Trump and President Xi could meet at an Asia Pacific leaders’ summit in Santiago Chile to continue talks.
  • Nov 18th: A temporary license which allows Huawei, a Chinese telecommunications giant, to buy critical U.S. components expires.
  • Dec 15th: The U.S. is scheduled to impose a final round of tariffs, taxing every Chinese product that enters the country.

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