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The Brave Report: Market Commentary for August 2019

Click here for the .pdf version of this report: The Brave Report-August 2019

Let’s all get back to work…. Summer is drawing to a close, the kids are back at school and the big money traders and investors have returned from their houses in the Hamptons. So now we must figure out where we go from here.  Trade tensions continue to cloud global markets raising fears of an impending recession.  The rate complex has followed suit as investors rush to safety and we see more and more negative-yielding government debt from other developed nations.  Even with all these headwinds, the US stock market has still held up relatively well and a number of companies continue to pump out better than expected results. Most of this success has been driven by the strength of the consumer which has helped to prop up areas more impacted by new tariffs and global uncertainty. So, as we enter the fall and approach an election year, will the consumer be able to support the economy until some of these uncertainties are worked out or will we finally see the end of this 10-year bull market?

Market Overview

The markets sold off early in the month and then remained rangebound for the rest of the month as daily volatility picked up.  When the dust settled, the S&P 500 lost 1.8%, the Dow Industrials lost 1.7% and similar to other recent down months the Nasdaq was the big loser, dropping around 2.6%.  As is often the case in August, volumes dropped, and this can cause volatility to spike as short-term reactions to news are exaggerated.  Add to this the end of earnings season and the market tends to trade on macro news such as any trade war developments.  As we head into fall and traders return to the office it will be interesting to see if they look at the drop in August as a buying opportunity or they will continue to sit on the sidelines until any trade progress is made.  I think any period of consolidation this month will be a great time to add to any names or sectors that have been unfairly sold off on trade war news.

The fixed income side is where we saw most of the fireworks over the past month. The 10-year treasury opened the month yielding just above 2% but dropped to a low yield of around 1.44%.  We have now seen the 10-year rate get cut in half since the start of last December. Inversion along the curve also continues to be a topic of debate as at different points during the month we saw short term rates jump above longer rates.  Many pundits have been quick to use this opportunity to jump on the “recession is coming” train but it is important to not overreact as there are other economic fundamentals that need to be considered to justify this argument.

Trade War: If it feels like we talk about this every month, you would be correct but at this point so much about the future of the global economy and where this market goes next is impacted by these negotiations.  As I have pointed out in the past, the actual economic impact of the tariffs themselves is minimal but the impact it has on business confidence and corporate spending is enough to slow global growth which does have a lasting impact on markets. Most of the headwinds that the market is currently dealing with can be traced back to these trade tensions.  If a deal can be reached, then fears of slowing global growth get muted. Recession fears would dissipate and this, in turn, would lead to more certainty around where rates will go next. Underlying fundamentals in the economy like employment and inflation are currently at a comfortable level. The thing worrying most investors is where they will go next if a deal is not reached.

In terms of how this all spills over to investment decisions on the short run.  The markets seem to react to any small progress or setback quite rapidly. It is important that investors avoid reacting to these short-term impulses.  I am waiting for substantive progress before making any large-scale decisions.  I am using any sharp pullbacks to add to long term positions in quality names or sectors but am keeping a good amount of dry powder on the sidelines for when an actual deal is struck.  I would rather not speculate on when a deal gets done even if it means being a little late to the party if/when a deal is made.

Rates: As I mentioned above, we saw a rapid drop in rates over the past month.  Global growth fears have driven down yields in almost all other developed economies leading to negative interest rates.  Germany, Switzerland, France, the Netherlands and Japan all have negative yields on their 10-year government bonds.  If we look across all developed economies the US has the highest yielding debt.  This, coupled with a rush to safety, has driven up demand for US treasuries.  An investor would rather make 1.5% by buying the security of US treasuries than get paid nothing to lend money in Germany. With the speed we have seen rates drop over the past month I would not be surprised to see some consolidation in the current rate range but with the expectation of continued rate cuts by the Fed and little substantive progress on the trade front I doubt rates have bottomed domestically.

Consumer Strength: With all the uncertainty surrounding trade negotiations, Fed policy and the potential of a recession there are still some bright spots in the economy.  Most notably, the consumer is still spending.  If earnings from some of the biggest retailers like Walmart, Amazon and Target are any indication the consumer remains strong and the trickle-down from tariffs doesn’t seem to be putting a dent in spending.  Whether this will continue as more tariffs take effect is still to be determined but this kind of consumer strength is not often a sign of an impending recession, as many pundits are conveniently ignoring.  I am not saying that we will just be able to spend ourselves out of a recession but if this kind of consumer strength continues it is hard to see growth slowing any time soon.  It is important to note that this can change rapidly and if tariffs continue to get ratcheted up on more consumer goods than we could see a spillover to consumer spending habits. However, the President has little incentive to see this happen, especially considering he already delayed some tariffs for fear it would impact the Christmas spending season.

Strategy Commentary

I continue to maintain my equity exposure at slightly below normal.  We have seen a slight increase in trade tensions over the past month, so I have seen no need to add back to any positions. Much of this increase is negligible from an economic standpoint so until we see any meaningful progress or escalation, I will continue to maintain this allocation. As we have seen, things can change rapidly on this front so I will not hesitate to adjust my positioning should any material changes occur.

Domestically I continue to maintain an overweight to technology and consumer discretionary.  These two sectors have outperformed when any good news on the trade front comes out but also underperform the market with any negative headlines.  I missed out on some of the rushes to safety and probably should have increased my exposure to some of the more defensive sectors at some points but with the volatility increasing over the past month you can get yourself in trouble trying to time what sectors will perform best in the very short term.  I still expect some sort of trade deal to be worked out and when it does technology and consumer discretionary should benefit.

I am still underweight almost all international markets.  I have not cut my positions to zero but growth prospects in Europe continue to be muted and the uncertainty around China trade makes many emerging markets undesirable.  Again, if some progress is made, I think we could see a quick rebound in emerging Asia, specifically China but I don’t plan to increase my allocation until we see some positive movement from both sides.

I am still neutral on most of the fixed income complex. With the rapid drop in rates over the past month there was a very big missed opportunity but very few expected rates to drop at the pace they did.  With so many negative rates around the globe, I expect to see continued buying of US treasuries, but a continued drop could be muted by any adjustments in Fed policy or developments on the trade front.

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