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The Economy and the Markets | Third quarter 2019

  • The Federal Reserve (“Fed”) delivered two rate cuts during the quarter, but investors are more focused on whether the Fed’s toolkit is sufficient.
  • We expect the margin of safety to edge down as the record expansion ages, increasing volatility.
  • Risks are skewed towards lower growth, but we don’t see a recession yet.  

The market got its wish for some help from the Fed as policymakers lowered the federal funds target twice in the quarter. The S&P 500® set another record but stocks saw outflows as bond buyers flooded in. Inflation expectations softened, and growth projections barely budged. This raised concern that conventional policies may be less effective this time around.

Economic headwinds going into the fourth quarter are led by the global trade war and subsequent uncertainty as global supply chains are disrupted. On the bright side, lower rates are boosting housing, and the employment picture is solid. The same can’t be said for businesses where the outlook darkened in the quarter as uncertainty dampened investment. Global manufacturing hit the skids with both the United States and Europe toying with a contraction. Global trade slowed, and more tariffs are slated for the fourth quarter, hitting consumers for the first time. Analysts expect a year-over-year decline in earnings for the third quarter in a row. We don’t see an easy fix and expect continued pressure in the fourth quarter.

ISM Manufacturing PMI and CPB Merchandise World Trade Volume Index

World trade ism manufacturing pmi

Source: Bloomberg.  ISM Manufacturing PMI 3-month moving average and CPB Merchandise World Trade Volume Index month-over-month percentage 12-month moving average from 10/31/2014 – 9/30/2019.

The Fed joined other major central banks in easing conditions. While officials want to avoid getting into “catch-up” mode, the Federal Open Markets Committee is divided as officials weigh their desire to head off a downturn against fears of using too much dry powder while the economy is broadly in line with their mandate. The market is skeptical, pricing 3-4 rate cuts in the coming year. Investors are increasingly concerned that the Fed’s toolkit won’t be sufficient when the cycle finally turns. The yield curve has remained inverted since the middle of May, and the 30-year government bond rate reached an all-time low in August. Poor liquidity in overnight funding markets added to the anxiety as the Fed was caught flat-footed by tight funding conditions. We expect a lot more discussion about the effectiveness of policy tools in the coming quarters. Debate about the merits of fiscal stimulus vs. quantitative easing, negative interest rates, and yield curve targeting will keep market participants on their toes. Rhetoric going into the election next year is likely to heighten risk.

It has been a banner year for most asset classes so far in 2019, but a closer look reveals troubling signs. Strong equity returns are mostly a recovery from last year’s dismal performance. While the total return on the S&P 500® was over 20 percent year-to-date as of the end of the third quarter, since last September, 2018, the index has returned just over 4 percent. Despite touching a new record in late July, market leadership has moved to more defensive sectors, and continued momentum has been elusive. High grade corporates and high yield bonds produced year-to-date total returns of 13.20 percent and 11.41 percent, respectively on spreads that were flat to tighter. Long treasuries returned almost 25 percent over the last 12 months as investors sought refuge in government bonds. Such returns are more typical of “risk-off” periods. Underneath the veneer, markets are showing signs that investors lack confidence in the direction of the economy.

Despite easier monetary policy and solid performance across most asset classes, investors seem to be more focused on negatives. Sentiment is uninspired on slowing growth, earnings pressure and event risk. Market volatility in both interest rates and stocks continues to trend upwards as investors remain unconvinced that the Fed’s actions to date are enough to accelerate growth. Market participants are worried that the policy toolkit will be insufficient when the next downturn occurs. We expect the margin of safety to edge down as the expansion ages, increasing volatility. Given mixed economic signals and an assist from the Fed, it’s not clear that markets will go down from here.  Nonetheless, we are more tempered in our risk taking.  

Chicago Board Options Exchange Volatility Index (VIX)

Chicago board opt exchange vix

Source: Bloomberg. Chicago Board Options Exchange Volatility Index 60-day moving average from 9/29/2014 – 9/27/2019.  

Source is Bloomberg for all information, unless noted otherwise.

The S&P 500 Index is an unmanaged index of 500 stocks that is generally representative of the performance of larger companies in the U.S. Please note an investor cannot invest directly in an index.

CPB Merchandise World Trade Volume Index measures global trade volume and was developed by the CPB Netherlands Bureau for Economic Policy Analysis.

The VIX Index is a calculation designed to produce a measure of constant, 30-day expected volatility of the U.S. stock market, derived from real-time, mid-quote prices of S&P 500® Index (SPXSM) call and put options.

The Institute of Supply Management (ISM) Manufacturing Purchasing Managers Index (PMI) Report on Business is based on data compiled from monthly replies to questions asked of purchasing and supply executives in over 400 industrial companies. The PMI is a composite index based on the seasonally adjusted diffusion indices for five of the indicators with varying weights: New Orders - 30% Production - 25% Employment - 20% Supplier Deliveries - 15% and Inventories - 10%.

Nothing contained herein constitutes investment, legal, tax or other advice nor is it to be relied on in making an investment or other decision.

This commentary should not be viewed as a current or past recommendation or a solicitation of an offer to buy or sell any securities or to adopt any investment strategy. Investments will fluctuate and when redeemed may be worth more or less than originally invested. Past performance is not indicative of future results. Opinions expressed herein are those of Securian Asset Management, Inc., only. Investors should keep in mind that markets are volatile and unpredictable. Past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. This article contains forward-looking statements based on expectations and assumptions. Actual results could differ materially because of changes to these expectations and assumptions. The Economy and the Markets has been prepared for informational purposes only and is the opinion of Securian Asset Management, Inc., a registered investment advisor.

Securian Asset Management, Inc., is a subsidiary of Securian Financial Group, Inc.

Approved for use with the general public.

DOFU: 10-2019