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The Brave Report: Market Commentary for September 2019

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

Why so nervous?  While the markets edged higher over the past month, we are starting to see a case of the jitters as investors have become more reactive to even the smallest news stories.  Part of this can be attributed to the lack of corporate data coming out over the last month but this type of nervousness is often a sign that investors are searching for the next short-term directional move in the markets.  Market bulls are searching for reasons to keep buying but when the catalysts start to dry up we can see outsized moves to the downside on any negative news as bulls run to the sidelines. With the absence of any constructive financial news, this should cause an uptick in volatility and may lead to a short-term pullback.  With that said, if we get any positive catalysts, I expect to see the buyers rush back in, especially with earnings season on the horizon and trade talks about to resume with China. Traders don’t want to be on the wrong side if trade war progress is made and earnings surprise to the upside. On the other side, investors don’t want to be the last one out the door either.  This kind of polarized environment can make it very difficult for the average investor and increases the need for investors to be patient and think longer term.

Market Overview

The major indices all edged higher during the month of September but finished a few percentage points off the mid-month highs.  The S&P 500 was up 1.7 while the Dow Industrials rose 2.4%.  The NASDAQ was the laggard, eking out a gain of around 0.4%. The markets rallied to start the month, making back most of the losses from August but ran out of steam as the S&P failed to push above the July all-time highs.  This now puts the markets in a bit of no man’s land, searching for some directionality.  However, the next month will provide us with a plethora of market-moving information.  Trade negotiations, earnings data and a Fed meeting should help to paint a picture of where the economy is going for the rest of the year.  As I mentioned, I expect volatility to pick up as this information is digested and traders decide if global growth fears are overdone.

On the fixed-income side, volatility seems to now be the norm.  Rates rose rapidly for the first half of the month, with the yield on the 10-year jumping from a low of 1.43% to above 1.9% in a week and a half.  This upward pressure subsided as the month progressed and rates settled back into the 1.60s.  Similar to the equity side of things we are seeing rapid swings on any news as investors rush in and out of safety and try to predict where the Fed is going next.  Rates globally still remain near all-time lows with a number of developed countries still maintaining negative rates.  While the US rates are not quite that low, they still sit near historic lows. With trade war uncertainty still hanging over the business world I expect these sudden rushes to safety to continue until we get some resolution.

Impeachment Inquiry: Over the past year or so I have discussed how uncertainty has been the driving force behind markets and has been the key for short-term directionality.  This has primarily centered around the trade war and Fed policy. We have seen moves in both directions as the outlook for both of these uncertainties becomes more and less clear.

We now have an additional uncertainty to add to the list as calls for impeachment have ramped up over the past month.  In question is a phone call from President Trump to the president of Ukraine.  It is not my job to debate the validity or justification of the impeachment inquiry but to try to understand how it impacts my clients and their investments.  With the absence of a smoking gun, we can expect the cloud of impeachment to become a distraction as the process plays out and is dragged through an election year. The impacts will be far-reaching as it becomes a new variable in the trade war and any other policy progress.  Will this embolden the President to get a trade deal done to help distract from the negative press brought on by impeachment or will this weaken our negotiating stance as China becomes more comfortable waiting for a new administration to negotiate with on a long-term trade deal? I do not think a full impeachment will become a reality unless some major new facts are revealed but that will not stop the democrats from turning this into a political circus.  This will push a number of other policy initiatives like infrastructure reform to the back burner and could essentially bring Washington to more of a standstill than it is already in.

Trade War:  Negotiations are set to resume as a high-ranking Chinese delegation is set to come to Washington in the next week. It will be interesting to see how this round of negotiations plays out.  There are several different variables at play heading into these negotiations and many of them are at odds. The President is in desperate need of a win going into the election cycle and a positive trade agreement would fit the bill.  While I have expected a trade deal to materialize at some point between now and the election, I now think there is a much greater chance of a piecemeal agreement rather than a full, comprehensive deal at this point.

While the President desperately wants to be able to tout a major presidency defining win, reaching a trade deal now is at odds with his other desire for the Fed to cut rates.  The Fed has cut rates, in part, because of the prospect of slowing global growth.  The driving force behind this slowdown is the trade war with China.  If a comprehensive trade agreement is reached it would reset the global economic outlook and reduce the need to cut rates.

Layer on top of this the Chinese stance.  The absence of an upcoming election gives them a much longer-term focus and allows them to be much more patient.  If they feel the impeachment inquiry is going to go anywhere or Trump’s prospects of reelection are dropping, they are much more likely to delay any deal.  They know Trump has tied his presidency to stock market performance and as the election draws closer is much more likely to blink at the negotiating table.  They also would probably be more comfortable negotiating with the next administration if Trump loses (depending on who it is). This all lowers their incentive to get something done and creates a situation where they are much more likely to agree to a watered-down agreement now while they wait to see what happens on the US political front.

From an investment standpoint, all of these “what ifs” make it very difficult to operate in the short-term.  The market is moving rapidly on any news and any news that is coming out seems to not be very material.  For the long-term investor, it is important to not let emotion drive any short term investment decisions.  We will see volatility but when actual material events occur those that have been patient should be rewarded.  As I have mentioned on a few previous occasions, if we see any sharp market-wide pullbacks it creates a great opportunity to buy high-quality names on sale, especially those with little exposure to trade with China.  I think this dynamic will exist throughout the next year or until we get some substantial clarity around trade.

Strategy Commentary

I continue to maintain the same equity allocation as a month ago.  Nothing material has changed so I am still holding my equity allocation at slightly below normal.  So much of the global growth fear is tied to uncertainty around the trade war. Until we start to get some information out of the upcoming trade talks, I do not expect to make any substantive changes.  While my expectations from the meetings are muted, we should get an idea if any progress or deterioration is happening and this should help to inform any upcoming allocation changes.

Domestically I am still maintaining an overweight to Technology and Consumer Discretionary.  These sectors have been quite volatile and seem to react considerably to any trade news. I continue to regret not adding to my Utilities position earlier this year as this sector has been the biggest outperformer.  I did not expect the trade talks to be so drawn out and expected the rush to more defensive sectors to be short-lived.  As uncertainty over trade has continued for more than a year, more investors have been rotating out of the growth sectors and into more defensive areas.  This rotation will reverse if any progress is made on the trade war but this, again, is the big “what if.”

I am still staying away from most international markets.  The valuations in both Europe and Asia are looking more attractive but growth prospects and political uncertainty in the EU makes it difficult to increase exposure there.  If we continue to see a rotation into value, I may start to look more at some of the higher dividend, value plays in Europe. We have seen some of the big banks become more constructive on the region over the past month, but I am in no rush to get in. Additionally, if there is progress on the trade front with China, I will be quick to start increasing my exposure there, especially to higher-quality names that have been kept down by trade uncertainty.

With the uptick in volatility in rates, I am starting to look at some opportunities in the space.  I expect the Fed to cut rates again in one of their next two meetings. However, if the trade war sees any progress during the upcoming talks, the rush to safety will probably slow and this would put some upward pressure on domestic rates. For now, I am maintaining my neutral stance on fixed income.