The last week’s market highlights:
Quote of the week:
“There’s no substitute for guts.” – Paul “Bear” Bryant
Each week, we present our featured topics in the context of the major themes listed below from Nuveen’s Midyear Outlook :
- U.S. economy: Late cycle but no recession
- Global economy: Still looking for a bottom
- Policy watch: Easy monetary policy to offset restrictive trade policy
- Fixed income: Volatile interest rates but no breakout in either direction
- Equities: Get defensive, stay invested
- Asset allocation: No longer “risk on,” but still prefer emerging-market bonds
Global economy: Events in Saudi Arabia and Montana fuel market action
Last week was (finally) shaping up to be one free of U.S./China trade headlines. On Wall Street early Friday afternoon, traders were watching to see if the S&P 500 could eke out a gain and extend its string of positive returns to four straight weeks. But neither came to pass. Reports surfaced that a Chinese trade delegation had cancelled plans to visit Montana farms. The trip was designed to build goodwill ahead of high-level U.S./China talks scheduled to begin in October.
For the time being, this event overshadowed the Saturday, September 14 attack on two of Saudi Arabia’s oil processing centers, which knocked out about 5% of global crude supply.
Oil prices soared in response. The price of Brent crude, the world’s most widely used oil benchmark, rose 14.3% on September 16—its largest-one day percentage gain since July 1998—to $68.79 per barrel. Brent retreated to $64.28 by the end of the week as the Saudis reassured markets that all necessary activities to restore production would be finished before the end of September.
While U.S. energy stocks rallied hard (+3.3%) on Monday in tandem with the spike in Brent, the S&P 500 Index lost only 0.3%, and the yield on the bellwether 10-year U.S. Treasury fell just 6 basis points (0.06%), to 1.84%. These subdued responses reflect the rapid growth of U.S. crude oil production and exports, which has dramatically lessened the impact of Middle East geopolitical risk on financial markets and the U.S. economy.
Although there’s no ideal time for a shock to the world’s oil supply, this one came at a particularly inopportune time given already slow global growth, sluggish demand and higher taxes on trade. And last week brought two disappointing data releases from China: Industrial output in August skidded to an 18-year low, and retail sales rose at one of their weakest paces since 2005 despite Beijing’s persistent consumer stimulus efforts. China consumes a lot of oil (about 13 million barrels a day, trailing only the U.S. in terms of consumption) while producing relatively little (about 5 million). Its economy could face further headwinds if oil prices rise substantially.
For the U.S., higher oil prices are a bit of a mixed bag. On the positive side, they encourage energy companies to amp up capital spending. According to derivatives marketplace CME Group, the oil and gas industry will allocate between $1.05 trillion to $1.3 trillion on regional infrastructure projects between 2017 and 2035. Increased investment requires additional labor—not just drilling crews, truck drivers and loader operators, but better paid technology workers and contractors. All these employees, in turn, boost local economies by purchasing homes, cars and other consumer goods.
In contrast, a pickup in oil prices, which translates to steeper gasoline costs, acts as a tax on businesses and consumers alike. Everything from flying to shipping produce to filling up at the pump becomes more expensive. Moreover, rising gas prices can dent consumer confidence. With the national average of regular gas at $2.67/gallon (according to AAA), a jump to the psychologically significant $3 per gallon mark, were it to happen, could have an outsized downward effect on Americans’ psyches, prompting a pullback in spending. Fortunately, high savings rates, growing wages and relatively low debt service costs should help consumers remain resilient even in the face of a sustained increase in gasoline prices.
But for all of Monday’s oil-related fireworks, the U.S. economy should continue to chug along. The Conference Board’s index of leading economic indicators for September pointed to a “slow but still expanding economy,” driven by strong consumer spending and robust job growth. Moreover, the housing market, which has been struggling for the better part of a year, may be poised to provide a spark. Housing starts surged in August to their highest level since 2007, and building permits, a forward-looking indicator, also rose sharply. Low mortgage rates may bring would-be buyers off the sidelines, lending further support to the sector.
Policy watch: A divided Fed shaves a little more off the top
As expected, the Federal Reserve followed up its 25 basis-point-cut in July with a similar move on September 18, lowering its target federal funds rate to 1.75%-2.00%. While U.S. economic data has generally remained solid, the Fed was concerned that weak global growth and trade-related uncertainty could derail the U.S. economic expansion.
The Fed’s policy statement contained relatively few changes compared to July. One “tweak” noted that exports and business fixed investment had declined—byproducts of President Trump’s aggressive trade policy. The Fed’s summary of economic projections also varied little. The Fed now anticipates that GDP growth will slow from 2.2% in 2019 to 2% in 2020, and to below 2% in 2021-2022. Unemployment and core inflation should hold steady in the near term.
An area that caused Fed watchers to see spots was the “dot plot” of interest-rate projections, which showed an unusual level of division in the 17-member Federal Open Market Committee (FOMC)—the group within the Federal Reserve that sets monetary policy. Five members did not believe last week’s rate reduction was warranted. Of the 12 who did, only seven expect the Fed to ease once more in 2019. Such a split is relatively rare and underscored the division on the FOMC. No members foresee more than one additional rate cut over any time horizon.
In his press conference, Fed Chair Jerome Powell sounded upbeat about the economy, particularly the U.S. consumer and jobs market. Nonetheless, he and his colleagues still think that modest interest-rate reductions act as a low-cost insurance policy against a future decline in economic conditions.
That said, we doubt that last week’s rate cut—or even two more rate cuts before year-end—will provide much of a boost to the U.S. economy. U.S. companies aren’t being restrained by high costs of capital—not with Treasury yields near historically low levels. The bigger issue, in our view, is that U.S. companies with global supply chains will likely forego new investments until the two sides strike at least a semi-permanent trade deal.