Despite a quarter filled with nervy headlines ranging from recession risks, political turmoil and global uncertainty, domestic equity markets managed to produce modest gains. The Russell 3000 Index, one of the broadest measures of US stock market performance, advanced +1.2% during the third quarter and is up +20.1% year-to-date. Including the -14.3% selloff that took place during the fourth quarter of last year, the Russell 3000 is up +2.9% over a trailing twelve-month period – by no means an ideal annual return, but a solid recovery nonetheless from what was viewed at the time as the potential beginning of a bear market.
Elsewhere, international stocks lagged their domestic counterparts, falling -1.8% on the quarter for a YTD gain of +11.6% per the MSCI ACWI ex-US Index. International stocks are still down -1.3% from this time one year ago, further evidence that US equities are leading the way in this market environment. Within fixed income, bonds produced another quarter of gains on the back of falling interest rates, with the Bloomberg Barclays US Aggregate Bond Index advancing +2.3% QTD for a gain of +8.5% so far in 2019. 10-year Treasury yields fell from 2.0% at the end of Q2 to 1.7% as of the most recent quarter-end, even briefly dipping below 1.5% in August. The Federal Reserve enacted two separate quarter-point rate cuts during the quarter, lowing its target Federal Funds rate from 2.5% to 2.0%, citing concerns over a slowdown in global growth. A popular safe haven investment, gold prices climbed +5.4% in Q3 for a +13.5% gain YTD.
As we look to the final three months of the year, we encounter a familiar narrative involving strong markets in the midst of negative headlines. Below we review some of the potential drivers of risk and return through the lens of our proprietary Three Dials methodology, all of which are unchanged from last quarter:
2019 has seen stock markets largely shrugging off negative narratives in the pursuit of new all-time highs, with the blue-chip US-listed names leading the way. Given that the major equity indexes, both at home and abroad, have at least found support levels well above the lows seen in 2018, our Momentum Dial remains in a “Positive” position through the end of Q3.
The Institute for Supply Management’s manufacturing index posted its lowest reading in September since the Great Recession, leading to much handwringing over when the next recession might be upon us. That said, an equivalent manufacturing index published by IHM Markit hit a 5-month high in August, well above contractionary levels, suggesting conflicting reports about the state of the manufacturing industry. While continued uncertainty around the China trade war is certainly sending negative shockwaves through parts of the economy, it is also the case that unemployment continues to fall, financial conditions remain accommodative, and leading economic indictors on the whole are strong enough to keep our Fundamental Dial in a “Positive” reading.
Valuation remains a concern from our end. Though a simple price-to-earnings ratio appears to be within historical norms, elevated profit margins indicate that earnings may be stretched beyond what is sustainable. As such, our Valuation Dial remains in a “Negative” position.
On balance, our Three Dials composite reading takes a “Cautiously Optimistic” stance, as strong showings in the areas of Momentum and Economic Fundamentals are balanced by Valuation concerns.
Sources:
https://apps.newyorkfed.org/markets/autorates/fed%20funds
https://www.instituteforsupplymanagement.org/ISMReport/MfgROB.cfm?SSO=1
https://www.bls.gov/news.release/empsit.nr0.htm
https://www.yardeni.com/pub/sp500margin.pdf