Zigs and Zags
The US stock market continued its volatile streak from October and gave investors more whiplash in November. US large-cap stocks have receded in the neighborhood of 7.5% since reaching all-time highs in the first few days of October. US small-caps are on a worsening record. From their October high, they have come down in excess of 15% and are plausibly in a correction.
Unravelling in foreign markets hasn’t yet been exhausted either. The exasperation in international stock markets are in lockstep with the US stock market’s pursuit to find a new bottom. As a whole, broader international stock markets are nearing correction levels this year.
“The exasperation in international stock markets are in lockstep with the US stock market’s pursuit to find a new bottom. As a whole, broader international stock markets are nearing correction levels this year.”
Today’s narrative for the global sell-off encompasses a wide range of issues. For one, a global slowdown could materialize in the coming quarters ahead. Investors also worry that the runway of historical quantitative easing is nearing an end. What’s more, the quantitative programs may actually fail in the long-term if asset prices were to deflate without the steroid. Further, political risks are much more elevated especially as tensions grow between China and the US.
In fact, the US government bond market is expressing its own outlook for US growth. The yield-curve of US treasury securities is testing levels where longer-term yields may sink below shorter-term yields. An inverted yield curve is a common predictor for a future recession. The yield-curve essentially trades flat right now, but is hazardously close to an inversion.
In early November, the Federal Reserve Bank raised interest rates another 0.25%. When the Fed raised, they told markets that more increases were on the way. Stock markets found the message to be agnostic to some of the brewing economic risks, and subsequently sold stocks. The Fed realizing their error, capitulated to the markets in late November by clarifying that they thought interest rates were close to normal. Stock markets, then, put-up a month-end rally.
The new US tariffs and the US and Chinese trade overhang are also complicating markets. Additionally, the American President does not appear willing to back down on his rhetoric recently calling himself a “tariff man” on social media. Trade conflicts have put the markets on edge almost daily. The stock market rallies when the White House has something positive to
say, but the rallies fade like clockwork as soon as the President gets tough again.
Policy aside, the US economy is actually doing quite well. Third-quarter output produced an annualized growth rate of 3.5%. Employment trends, consumer spending and household debt-levels are all generally positive. And, inflationary trends are moderate for consumers. Of course, these are all lagging economic indicators and are not foreshadowing the future state of the economy.
With that being said, there are some cracks in the US economy, most notably in construction spending and housing data. The nation’s double deficits (government spending and trade), are likely problems that must be dealt with in the future. Manufacturing is also challenged by rising input costs, namely from tariffs, and is held back by capacity constraints. Further, consumers may encounter above normal price increases on goods and services in the near-term. The Fed would be put in an uncomfortable situation in a scenario where prices are rising, growth is slowing, and asset prices are falling. The only permanent solution to escape this type of stagflation, is continued gains in US productivity. Fortunately, US productivity has sustained a healthy level of growth this year, which has safeguarded the economy so far.
Throughout the past decade, global economies have gotten juiced by stimulus. The same could be said about asset prices. Investors have been in an environment where bonds have underperformed and stocks have outperformed. The fact that value assets have so drastically underperformed growthier assets may offer some evidence. Volatility is inevitable, especially given the length of the current bull market. Regardless of this volatility, aspects of the global equity markets are still attractive and these assets are crucial for most investors.
Stocks swung between gains and losses in the month of November. However, stocks finished the month positive after the Federal Reserve Bank moderated language regarding future interest rate increases. In what has been a volatile fourth quarter for stock markets, last month’s gains came as a sigh of relief. Investors largely benefit from holding diversified portfolios in periods of uncertainty. However, markets go through cycles. There are times when a single group of assets (such as foreign stocks, commodities, bonds, etc) outperform all others. Although we’ve been in an environment where US stocks have outperformed, the recent volatility is a strong reminder of the risk associated with a single asset class. In November, our diversified CORE Allocation portfolios outperformed Morningstar’s World Allocation category average on a risk adjusted basis. This trend has been evident for the prior quarter and year-to-date as well.