US Market Viewpoints: September 30, 2019Submitted by Castlebar Asset Management on October 3rd, 2019
There was a lot of noise this quarter but stocks remained largely a narrow range. The S&P 500 squeezed out small gains. We remain just 1.2% away from all time highs set earlier this year. Recession fears crept into the conversation for both Wall Street and Main Street. If you look at Google Trends, the word recession was searched most on August 14th. Coincidently, that was the same date the S&P 500 reached its lows for the quarter. The continuation of the US-China trade war is having a direct impact on some companies and economic data. A slow down in the manufacturing sector has raised some concerns that a recession may be closer than previously thought. Despite these concerns, this has been the best performance through three quarters since 1997.
Larger market cap stocks continued their recent trend of outperforming smaller companies. Large cap stocks had a positive performance of 1.8% while small companies pulled back about 2.4% in the quarter. The reason large cap companies outperformed again this quarter is investors believe they are in a better position to navigate the trade war environment. Larger companies also typically have better balance sheets and are being rewarded because this offers them more financial flexibility. Value stocks outperformed growth in the quarter in both large and small caps. There was a shift mid quarter as investors rotated out of growth orientated stocks and bought value stocks. Low volatility stocks outperformed both value and growth.
Income orientated stock sectors were the top performers in the quarter. Utilities and real estate names gained 9.3% and 8.0% respectively in the quarter. Investors shifted money into these two sectors because their dividend yields are higher than what bonds and CDs are offering as interest rates declined in the quarter. Consumer staples gained 6.4% as money shifted into more defensive focused sectors. Energy and health care stocks were the weakest performers in the quarter. The energy sector declined by 6.2% and was very volatile. Energy fell over 12% until a drone strike against Saudi Arabian oil facilities caused the sector to almost rally back to even, only to give back those returns as crude prices could not hold their gains. Healthcare struggled and fell 1.9%. The reason for the sell off in healthcare is because of political uncertainty surrounding the health insurance market and future reimbursement rates for the sector.
There is a split in the economic data that is telling two different stories. The consumer and service focused areas in the economy are doing well. This is because of low unemployment, a tight labor market, and low interest rates. This does represent a large percentage of the US economy. Manufacturing is struggling right now and this is a direct impact of the trade war. Both the US and global manufacturing data are weak with global manufacturers contracting at a quicker pace than the US. The weakness in manufacturing does have us concerned because it usually weakens shortly before a recession starts. We have seen manufacturing data decline and contract in 2014 and 2015 and we did not enter a recession. This is something we will watch closely in the coming months.
Market valuations are slightly above average but are nowhere near bubble territory. Given we remain in a low and stable inflation environment and interest rates are declining, it is normal to see valuations drift higher. Market valuations are not a cause for concern. We do not expect to see an increase in the market P/E ratio from current levels. This means that future upside for the market is going to be tied to earnings growth. We expect there to be modest growth in earnings but there are a lot of headwinds, as discussed above. The trade war has yet to impact consumers and as long as consumers in the US are spending, earnings growth should remain steady. However, surveys from CFOs and other business executives reveal they are less optimistic about the economy.
We are taking a more cautious stance with our portfolios given the macroeconomic environment. This does not mean we expect a recession or stock market decline in the near term. We do see the risk of recession today is greater because of the weakness in the manufacturing sector. Our strategy is to try to capture as much of the upside as we can if markets continue to move higher but focus on offering downside protection. We have added low volatility ETFs or built stock portfolios that have less volatility than the broader market. This is our first shift towards a more conservative stance. You may also see us slowly increase your cash holdings in your portfolio. We do not plan to make any dramatic shifts but you should expect to see your cash holdings drift higher in the current quarter if we continue to have concerns.
We have not addressed the elephant in the room. The House of Representatives is opening an impeachment inquiry against President Trump. Political risks are something investors must accept when investing. The news that the impeachment process has started should have a limited impact on the markets in the long term. When it comes to investing we encourage clients to remove their political leanings and focus on the market data that drive market performance.
Disclaimer: The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results.