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| The S&P 500 sails off into uncharted territory. While the waters appear calm, distant clouds indicate the very real possibility of either sunshine or storms ahead |
October has been a no good, downright bad month. Oh wait- scratch that. That’s just how the month started. Now, coming into November, markets have once again risen to near-historic levels! The S&P 500 advanced no less than 2.0% for the month, but actually trailed in performance the tech-heavy Nasdaq (up +3.7%) and even the small cap Russell 2000’s 2.6% gain. Oh yes, the Dow rose about half a percent for the same period.
We’ll get to the “why” in a few minutes, but first, let’s just revel in what a month it was. Traders – not investors, mind you, who sleep well at night with their diversified, well-positioned portfolios – started the month getting tossed about as the market tried to gain traction on mixed messages and random, yet tangentially-related flare ups (hello, Daryl Morey! Yes, this refers to you, and the NBA, and… of all places, Hong Kong?) and flare downs (Saudi Arabia managed to bring 5.7M bpd of oil production back online at the end of September after just two weeks of downtime following the September 15th attack on Abqaiq).
While the S&P 500 did initially break below the 50-day and 100-day moving averages (two key technical levels), markets soon began to gain traction throughout the month on the back of solid third quarter earnings and improving trade rhetoric. And yes, the Fed did help by cutting rate targets for the third time this year. In other words, investor sentiment, better-than-expected earnings, the Fed rate cut, and the hope for a November or December US-China interim trade deal set the stage for current market optimism.
Tailwinds for November
Growing US-China Trade Optimism
Since the US and China negotiations teams met, rhetoric has improved from both countries and discussions for a preliminary “Phase 1” interim could come as early as this month (or next, since November’s meeting location was just canceled). On an ideological level, the US government is seeking what is basically a level playing field with China through the concept of “reciprocity”. What exactly that looks like and how this will function between a capitalist and communist government and economic system remains to be seen. Any breakdown in talks will have a negative effect on trade-sensitive sectors, so The Ignorant Investor views continues to advise investors to watch ongoing discussions with cautious optimism. As always, consult with your investment professionals before making any investment decisions!
Solid US Third Quarter Earnings
Analysts entered Q3’19 with a dismal view of how companies were going to perform on the top and the bottom lines. For the most part, companies – once again – put on a performance that exceeded expectations. The vast majority of S&P 500 companies proved to be more resilient to headwinds than initially feared, with relatively solid to strong results across many industries.
Note that this assessment doesn’t include the many ugly unicorns out there that continuously hemorrhage dollars while promising future profitability (*cough* WeWork *cough*).
Relatively Accommodative Federal Reserve Policy.
On October 29th, the US Federal Reserve voted on a third rate cut for 2019. The Federal Funds rate target is now set for the 1.5 – 1.75% range, now down three quarters of a percent since the last rate hike in 2018. Fed Chairman Powell indicated in his speech that this will likely be the last rate cut for 2019, with the Fed adopted a “wait and see” attitude (granted, despite all of Trump’s criticism, the stock market is near all-time highs and economic data outside of manufacturing appears solid; let’s wait to see that jobs report!). Read more details about the Fed rate cut at CNN.
Perhaps unrelated yet of note, since the attack on Saudi’s oil facility in September, the Fed has been forced to occasionally step into markets and inject liquidity to bring the Federal funds rate back into the target range amid several overnight liquidity crunches.
Lingering October Clouds (Grey Swans)
Brittle US-China Trade Negotiations
While both leaders arguably need their respective teams involved in negotiations, a number of ideological and logistical issues could arise with the potential to derail talks. A short list that is by no means comprehensive is below.
- The intentions of China for trade negotiations remains unknown. An interim US-China trade pact may be signed in November (or December), but with 2020 elections fast approaching, the question remains whether China will simply play its role and hope for a new US president to negotiate with following the next election.
- A second divergence can occur as a result of differing trade goals. China remains committed to the state being heavily involved with industry and may be willing to make only superficial changes for the appearance of an open economy. To this end, trade agreement enforcement mechanisms could again become sticking points.
- A third conflict can arise from Trump and his allies seeking to limit investment in China. The Trump administration has been actively discussing methods for blocking US investment in China. One method could bar government pension funds from investing in Chinese firms (read about Senator Marco Rubio’s legislative plan at Bloomberg). Another method could bar Chinese firms from listing on US exchanges (think Nasdaq) or exclude them from indexes.
- A fourth issue can arise from outside factors. China is increasingly flexing its image on the international stage, carefully choreographing how it is presented and becoming incensed at any perceived form of criticism- often punishing the source of that criticism wherever it may be found. The US has recently blocked twenty-eight Chinese firms from doing business with US companies for helping the Chinese government in Xinjiang. Similar actions around more sensitive topics could affect trade negotiations.
While the US-China trade negotiations take center stage, there are developments on the US-EU front that could lay the groundwork for fresh disputes. The World Trade Organization finally ruled on a US-EU trade dispute around subsidies for Airbus (a separate dispute before the WTO on Boeing continues). As part of the ruling, the WTO allowed the US to impose tariffs on up to $7.5 billion of European goods. The Trump administration immediately came up with a list of products from “France, Germany, Spain, and the United Kingdom” that will be targeted by tariffs (read more at the Office of the US Trade Representative here). Retaliation by Europe for these WTO-authorized tariffs could induce another trade conflict that could affect global economic growth.
Impeachment Proceedings
While Republicans continue to hold the Senate, investors are adopting a wait and see approach to the House of Representatives’ impeachment proceedings. Until a smoking gun is found, the status quo appears to be assumed into 2020 elections.
Hong Kong Protest
Hong Kong risks to the US financial system remain slight, but flare ups of temperament could potentially blow back on multinationals, industries, or – in an extreme case – US-China trade negotiations. Houston Rocket’s GM Daryl Morey’s tweet regarding Hong Kong threw the NBA into the unenviable position of defending free speech against an angry China and then walking back mixed messages in the face of a subsequently indignant US public.
Multinational companies operating in the region are increasingly thrown into similarly complicated predicaments as the protests continue. Should China choose to take a less measured approach to the protests, these situations for companies operating the region – and perhaps for Western governments – will become more complicated.
What happened to September?
Yes, yes. The Ignorant Investor pleads guilty to missing a September update. My apologies. Family and work obligations piled up fast and thick amid a heavy travel schedule towards the end of the month and a brief sketch for a writeup never made it onto the website. The silver lining is that now The Ignorant Investor has learned how to schedule posts and will do so in the future to avoid this conundrum.
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With markets reaching historic levels, The Ignorant Investor again urges caution. It's never fun to chase a rally you're not already participating in! This seems like a good place to end with a Warren Buffet quote, where he compares baseball to investing: "...the most important thing – for a batter – is to wait for the right pitch. And that’s exactly the philosophy I have about investing - wait for the right pitch, and wait for the right deal. And it will come."
