Market Commentary Q3 2019

The market today reminds me of a conversation between my in-laws regarding liver sausage and whether it was good or not.  My wife, who hates liver sausage, was arguing with my mother-in-law who loves liver sausage.  Everyone surrounding the conversation had very passionate thoughts about the food and, since they were all family, those thoughts were shared.  There was no middling ground.  Liver sausage was either incredible or disgusting.

The market today is not so different.  There are clients, economists and investors that love this market.  There’s also clients, economists and investors who very much dislike this market.

Essentially this market is liver sausage.

Sentiment Versus Action

Consumer Sentiment is a statistical measurement that expresses how consumers view the economy.  It doesn’t measure the economy itself, but the average individual’s perception.  The higher the number indicates the more optimistic the average individual is on the health of our economy. At 102.40, the current Consumer sentiment indicates that the average individual perceives the economy to be very healthy.[1]  

The actions of the investor have been quite different.  Investors, year-to-date, have liquidated a net $53.46 billion from domestic equity mutual funds.[2]  So while consumer sentiment shows that the average investor has above average optimism in the health of our economy, they also want to reduce their exposure in the investments within that economy.

Recession Characteristics Versus Recession Indicators

Historically, one or more of three characteristics has been associated with every recession after 1945.  A recession has been due to either a commodity spike, extreme valuations and/or an aggressive Fed.  We are currently seeing none of those characteristics today.[3]

An inverted yield curve is an interest rate environment in which long term treasury yields are lower than short term treasury yields. Historically, inversions of the yield have preceded many of the U.S. recessions.  Due to this historical correlation, the yield curve is often seen as an accurate forecast.[4]

The first week of July we saw an almost fully inverted yield curve.[5]  This would indicate a possible recession, however with none of the recession characteristics showing we are noting the occurrence, but not yet reacting to it.

Manufacturing Disparity Versus Valuation Disparity

Purchasing Managers Index (PMI) for manufacturing is an index that shows the economic trends in manufacturing.  A number above 50 would indicate an expansion, or growth, within that country or region.  A number less than 50 would indicate contraction within that country or region.  Currently, the U.S. has a PMI of 50.5 (expansion) for June, while the global PMI is 49.40 (contraction)3.  This indicator shows us that, while U.S. manufacturing is expanding the rest of the world’s manufacturing is contracting. 

Forward P/E (Price-to-earnings) is a way to measure valuation in a stock, sector, market or region.  It takes the current price of the market and compares it to analyst’s expectations of earnings over the next 6 months.  You can look at Forward P/E compared to historical averages or compare them against other investments to see relative valuations.  The price of the S&P 500 is trading at 16.70 times earnings versus a 20 year average of 15.70 times earnings. The price of the ACWI ex-U.S. (the world less U.S. markets) is trading at 13.20 times earnings versus 14.0 times earnings.3  This means that the U.S. is trading slightly above historical valuations while the rest of the world is trading slightly below.  More importantly though is that the ACWI ex-US is trading at a discount of 21% to the S&P 500 versus a historical average of 11%.3 

This means that, while we are seeing signs of contraction overseas, we are also seeing much better value.  We are left deciding between growth of an economy versus value of an economy.

Leading Economic Index

A leading indicator is any economic factor that changes before the rest of the economy begins to go in a particular direction.[6]

The Leading Economic Index is an index made up of 10 combined leading economic indicators.  The index was unchanged in May, remaining at 111.80 after increasing in both April and March.[7]

While this does indicate moderate growth for the remainder of the year, it is also indicative of the current economic climate where the indicator did not rise or fall.

Conclusion

The economic climate is showing both positive signs and red flags.  This isn’t just limited to the U.S. either.  The data does suggest that diversification is becoming increasingly important as outlook remains positive for multiple markets and regions, but the horizon starts to get cloudier.