“I would rather sit on a pumpkin, and have it all to myself, than be crowded on a velvet cushion.” Henry David Thoreau, Walden
The stock market saw its biggest year-to-date gain in more than two decades.
The bond market lost ground last month, but dramatically outperformed the stock market in the trailing 12 months.
More signs emerged that we may be in the latter stages of this market cycle.
Thoreau’s well-worn quote tends to resonate with me this time of year — and not just because fall has arrived, bringing cooler weather in some parts, vibrant colors and, yes, plenty of pumpkins. Sitting on his pumpkin, Thoreau was a master of tuning out the noise of the crowds and focusing on his own goals, a lesson we as investors would do well to heed.
September had no shortage of noise. The U.S.-China trade war, rising tensions with Iran, slowing global growth, Brexit and the newly announced U.S. impeachment inquiry loomed large in the minds of many investors. Some of these issues have already produced sharp market shifts this year.
With troubling headlines piling up like fall leaves, it might’ve been easy last month to overlook the fact that the stock and bond markets entered the fourth quarter in solid shape. In fact, the S&P 500 index posted more than a typical year’s gain for the year-to-date period ending in September, returning nearly 21%. As was widely reported, the market saw its biggest year-to-date gain through September in more than two decades.
After declining in August — when the trade war dominated the headlines — the broader stock market rebounded last month, gaining nearly 2%. Stocks rose at home and abroad in early September when the U.S. and China announced plans to resume trade talks in October. Returns were especially strong among riskier assets, as non-U.S. developed markets, small-capitalization stocks and emerging markets all outperformed the S&P 500 index.
Last month, we also saw the beginnings of what may be a longer-term shift in the factors driving market performance. Since the financial crisis, the market has largely favored stocks that have done well in terms of share-price appreciation (known as momentum stocks) and shares of companies growing at above-average rates (known as growth stocks), while so-called value stocks have lagged on a relative basis. (Equity Market Update: Recent Rotation in Equity Factors; Goldman Sachs Investment Strategy Group, September 25, 2019).
But the tables turned in September, when momentum and growth stocks stumbled and value staged a comeback. Value stocks have stable fundamentals but tend to be undervalued by the market relative to their intrinsic value — in other words, they’re a relative bargain. “Whether we are talking about socks or stocks, I like buying quality merchandise when it is marked down,” famed value investor Warren Buffett once said when describing his strategy.
In September, changing market preferences also bled into the initial public offering (IPO) market, making it harder for startups to raise capital. IPOs of fast-growing, money-losing enterprises have generated plenty of buzz in recent years. Last month, however, brought fresh signs that market sentiment toward IPOs is cooling. One newly public startup saw its shares slump on its first day of trading, and a highly anticipated mega-IPO was shelved indefinitely.
U.S. Sector Scorecard
While defensive sectors — i.e., those that typically hold up relatively well during turbulent times, such as Utilities — were the winners in August, last month’s results were mixed. Here are a few takeaways:
Financials was the best-performing sector in September (up nearly 5%). Banks, brokerage firms and insurance companies tend to benefit when interest rates climb, as they did last month. After falling sharply in August, the yield on the benchmark 10-year Treasury note — which affects a variety of business and consumer loans — rebounded to nearly 1.9% in mid-September, before trending downward again.
Utilities, a defensive sector, continued to be a strong performer last month, gaining more than 4%. But Industrials and Materials — cyclical sectors that are seen as vulnerable to the trade war — also shined, each returning about 3% for the month.
Energy, one of the worst-performing S&P 500 sectors over the past year, got a boost last month after a large and unprecedented attack on Saudi Arabia’s oil infrastructure. The attack led to a spike in oil prices, but Saudi Arabia has since fully restored oil production and crude prices, as of early October, had reversed the gains they made in the attack’s aftermath. The Financial and Energy sectors also appeared to benefit last month from the more-robust appetite for value stocks.
In September, the U.S. bond market, which had rallied earlier in the year, lost some ground. Returns were negative across all sectors, with the exception of high-yield (or junk) bonds, which returned less than 1%.
US bond yields have been declining, driven by the twin pressures of looser monetary policy and slower economic growth. But the pressure has been even more acute abroad. In some developed markets, particularly Europe and Japan, government bond yields are negative. In an odd quirk, an investor who buys one of these negative-yielding bonds and holds the bond to maturity will actually lose money. Clearly many investors are willing to accept that marginally negative return in exchange for the security of parking their money with a sovereign issuer. As of mid-August, some $16 trillion of global bonds traded at negative yields, according to Bloomberg.
The Economy and the Fed
While the job market remains strong and wages are rising, we continue to see signs that we may be in the latter stages of this market cycle:
In late August, for instance, we saw another yield-curve inversion — a bond-market phenomenon that has been a reliable, yet early, recession indicator. The yield curve is a graph depicting current interest rates of bonds with different maturities. It inverts when the rates on longer-dated bonds drop below those of shorter-dated bonds, signaling that investors believe the economic picture will deteriorate over time. Longer-dated bonds typically have much higher yields than shorter-dated bonds since investors expect to earn more in exchange for tying up their money for longer stretches of time.
Manufacturing activity deteriorated for the second month in a row in September. The Institute for Supply Management’s closely watched monthly index of manufacturing activity (known as the PMI) fell to 47.8 last month, from 49.1 in August. A reading above 50 means the manufacturing economy — which is closely correlated to the overall economy — is expanding. Anything below 50 signals contraction.
Growing uncertainty may be starting to affect consumer sentiment, which has been an economic bright spot in recent months. The Conference Board’s closely watched Consumer Confidence Index fell to 125.1 in September from 134.2 the prior month, according to the board, which attributed the decline to an escalation in “trade and tariff tension.” Another closely watched consumer-sentiment index, produced by the University of Michigan, had more-upbeat results, rising to 93.2 in September from 89.8 in August, which represented its lowest level in three years. The university cited “favorable income trends, especially among middle-income households” for improving consumer sentiment in September.
The Federal Reserve, which has faced very public political pressure to cut rates, did so in September, for the second time since the financial crisis. Yet the central bank offered few indications that it intends to make further cuts, and appears to be divided (more so than in the past) about how to proceed on rates going forward.
In early September, John Williams, president and chief executive officer of the New York Fed, said “the economy is in a good place, but not without risk and uncertainty (there, I said it!).” Williams, who apparently has a sense of humor, serves as vice chair of the rate-setting Federal Open Market Committee and has voted in favor of recent rate cuts. “Our role,” Williams added, “is to navigate a complex and at times ambiguous outlook to keep the economy growing and strong.”
Like the Fed, investors are navigating a complex and fast-changing environment — which may be another reason to look to Thoreau’s time-tested words at a time when signs of change are literally all around us. After all, successful investing often involves enduring some short-term pain — or metaphorical pumpkin sitting — for longer-term gain.
Live richly and invest well,
Kara Murphy, CFA
Chief Investment Officer
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