Trade issues may continue to cause trouble but shouldn’t derail the bull market or end the economic expansion.
Investor sentiment was mixed last week. Negatives included concerns about market liquidity, sparked by the rising value of the U.S. dollar and fears of contagion from some emerging markets. Ongoing trade issues also posed a general concern, particularly fears surrounding a potential new round of U.S./Chinese tariffs. On the positive side, investors focused on strong U.S. economic data that pointed to accelerating growth. The negatives won in the end, as the S&P 500 Index fell 1% for the week, after rising during eight of the nine previous trading weeks.
Liquidity Concerns Appear Overstated
Some investors are growing more concerned about shrinking liquidity as the Federal Reserve raises rates and shrinks its balance sheet, the value of the dollar climbs and select emerging markets such as Turkey and Argentina experience currency crises. Of all of these factors, we are most concerned about the rising dollar. The increase is not overly problematic by itself, but we would be more worried if interest rates were higher and rising more quickly and/or if economic growth were decelerating.
On balance, we recognize that market liquidity is growing more constrained and the current economic cycle and equity bull market are in their later stages. But we believe such concerns are overwrought. The global banking system remains healthy and global monetary policy is still relatively easy, which suggests that a liquidity squeeze isn’t in the cards.
- After rising for most of the last few months, equity prices took a breather last week in the face of liquidity and trade worries.
- The U.S. economy appears to be re-accelerating and we see no imminent signs of a recession.
- Likewise, we think the risks for stocks are skewed to the upside and expect prices to rise modestly over the next year.
Top Themes of the Week
- The August labor report showed a strong jobs market and increasing wage growth. Payroll gains (up 201,000) were ahead of expectations, but , more importantly, the long-awaited acceleration in wages appears to be taking place. Average hourly earnings increased 0.4% for the month and 2.9% year over year, a new cycle high.
- Manufacturing levels are also accelerating. The August ISM Manufacturing Index rose from 58.1 to 61.3, its strongest reading since May 2004.
- Improving productivity levels should help continue the economic expansion. Rising capital expenditures appear to be improving productivity, which should help profit margins rise and could help suppress inflation.
- Near-term recession risks appear quite low. We see no signs of an imminent recession. If anything, we would be more concerned about economic growth overheating and interest rates and bond yields rising.
- Corporate management teams appear to be growing more concerned about trade issues. A recent report from Sanford C. Bernstein & Co. shows that companies are now more focused on the negatives from trade than they are on the positives from lower tax rates.
- Although investors are focusing on political negatives, we still see positives from the political backdrop. Trade issues rightfully remain in the headlines, but tax reform and an easier regulatory environment have supported consumer spending and helped promote higher capex levels.
- Early indications suggest that 2019 may present a more challenging economic and market environment. We believe earnings growth is likely to slow next year, while monetary policy around the world is likely to become less accommodative.