The last week’s market highlights:
Quote of the week:
“Most people do not listen with the intent to understand; they listen with the intent to reply." --Stephen R. Covey
Each week, we present our featured topics in the context of the major themes listed below from Nuveen’s 4Q 2019 Outlook :
- U.S. economy: Still seeing signs of growth
- Global economy: Downward pressure but no recession.
- Policy watch: Markets expect more easing
- Fixed income: Opt for high quality, longer maturity
- Equities: Get defensive, stay invested
- Asset allocation: While cautious, still prefer emerging-market bonds
Equity markets: Time to rotate
In 2019, the U.S./China trade war has been a dominant recurring theme for markets. But running beneath it has been a series of subplots.
Early in the year, investors fixed their eyes on the U.S. government shutdown, the longest in history.
In May, their attention turned to the inverted yield curve, as longer-dated Treasury yields fell below those on shorter maturities. This phenomenon, while relatively rare, stoked concerns because it has preceded every U.S. recession in the past 50 years. But the yield curve “uninverted” in mid-October thanks to solid economic data and optimism over trade. Since then, the yield on the bellwether 10-year Treasury note has remained above that of the 3-month T-bill, which has edged down due to expectations for continued accommodative Federal Reserve policy.7
With normalcy returning to the bond market, recent headlines have focused on a “great rotation” among equities—away from defensive stocks and toward more economically sensitive areas of the market.
During the first eight months of the year, amid rising U.S. recession fears and falling Treasury yields, investors turned to defensive sectors such as consumer staples, utilities, health care and telecommunications for their relatively high dividends and ability to retain principal. Demand for these sectors helped them deliver a combined 14.6% total return through August. Meanwhile, more economically sensitive sectors like energy, materials, consumer discretionary and industrials modestly underperformed, rising as a group by 14.1%.8
Since early September, though, cyclicals have once again grabbed the baton, gaining 5.7% versus 3.5% for defensive shares.9 Why the change in market leadership? We see three reasons:
- Heftier bond income. From July 26 to August 28, the yield on the bellwether 10-year Treasury fell from 2.08% to 1.47%, pushed down by deepening worries about lackluster growth and low inflation. But a little over half of that drop has since reversed.10 This higher risk-free payout has dented demand for defensive shares.
- A possible trade détente. Apparent progress in the U.S./China trade war has boosted risk appetites. Investors took heart from President Trump’s decision to cancel the October 15 tariff increase on about $250 billion of Chinese goods. Next they’ll watch to see if the president carries out tariffs on $150 billion of imports from China in December as scheduled and imposes trade taxes on European automobiles, as he has threatened to do.
- “Easier” central banks. Last week, Federal Reserve Chair Jerome Powell told U.S. lawmakers that the Fed is likely done with cutting interest rates unless the economy slows substantially in the coming months, which he doesn’t expect. But even with the Fed on hold, rates remain very low by historical standards. Meanwhile, the European Central Bank, in a bid to boost the slumbering eurozone economy, has restarted quantitative easing to the tune of €20 billion per month and will continue buying bonds “for as long as necessary.”
In our view, equities have already priced in the beneficial effects of these three factors. However, signs of a broad-based recovery in global growth or a further improvement in economic data could push stocks higher in the near term.
Equities: Individual investors say, “No, thanks.”
The S&P 500’s 2019 performance has been impressive. The index (+2.8% thus far in November and +26.5% for the year to date) is poised to enjoy its best year since 2013.11
It’s natural to think individual investors have participated in this rally. But rather than feeling emboldened after reviewing the positive returns in their 2019 monthly statements, everyday folks seemingly have been accentuating the negative this year, such as the trade, yield curve and political concerns mentioned in the previous section. Add to that the lingering pain of 2018’s fourth-quarter equity market selloff, the ongoing Brexit saga and a dash of Middle East tensions, and voilà!—a recipe for risk aversion.
The reluctance to put money into stocks is evident in weekly fund flow data. In 2019 to date, according to the Investment Company Institute, flows into U.S. equity mutual funds and ETFs have been negative 61% of the time (27/44 weeks, a total net outflow of $169 billion). In contrast, flows into bond funds have been positive 98% of the time (43/44 weeks, a $378 billion total net inflow). This skittish investor behavior is nothing new. Analysts have often described the current bull market, which began in March 2009, as “the most unloved in history.”
But the mood on Main Street may be changing. Following a decidedly bearish summer, the weekly American Association of Individual Investor (AAII) sentiment survey turned bullish about a month ago. (Respondents are asked simply whether stock prices will be higher or lower in six months.). Of course, market moves tend to drive investor sentiment over the short term, not the other way around. That’s one reason the AAII survey is viewed as a contrarian indicator. In fact, the AAII notes that “low levels of optimism have historically been associated with good buying opportunities.”
And though it’s best known for its short-term sentiment survey, the organization also offers sound advice that we take to heart: Focusing on long-term goals is far more important than trying to determine the direction of stock prices in the next six or 12 months.