Things Look Good (On the Surface)
The Dow Jones Industrial Average and the S&P 500 are up 15% and 20%, respectively, for the year, driving the value of U.S. stocks to a record of $32 trillion. United States’ household’s net worth is $113 trillion, far eclipsing the past peak of $71 trillion back in 2007 at the height of the housing bubble. Better domestic growth than elsewhere around the world, flush corporate profits, and accommodating capital markets are all positives for U.S. investors. These conditions have gone a long-way to lift asset values to today’s levels.
Diving Rates — Blessing or Curse?
The rise in asset values is helping to sustain economic momentum through more spending and jobs. The recent drop in interest rates drove the national average for 30-year mortgages down to 3.75% from 4.75% a year ago, for example. A year ago, mortgage and other rates were climbing, threatening to dampen borrowing and spending. The headwind of rising interest rates is now a tailwind as falling rates should help sustain borrowing.
Some attribute the fall in global interest rates through the early part of 2019 through mid-August to faltering growth around the world. All across the globe, bond yields plunged to record lows. The amount of negative-yielding global soared to $17 trillion from essentially nothing prior to 2015. Since August, the global value of negative yielding has declined somewhat to around $13 trillion. The phenomenon of negative rates at all, much less for trillions of dollars of outstanding debt, remains a puzzle and the intuition is hard to grasp. Whatever the cause, the sharp fall in long-term bond yields meant that returns on long-dated sovereign debt, like U.S. Treasuries, continued to dominate returns across the bond spectrum for most of the past year (chart A, below). Investors who opted to shorten maturities a year ago, fearing Federal Reserve rate increases, missed the boat.
Plunging yields had a significant impact on the relative performance of other assets, too. For the twelve months ended September 30, 2019, domestic large-cap value stocks eked out a small outperformance versus growth stocks (chart B, below left). Gold also rallied and outpaced other non-correlated assets such as global hedge funds (chart C, below right). Continued outperformance by long-term Treasuries and gold, both positively correlated with economic and political uncertainty, would be a troubling omen, especially after already significant rallies.
Charts B & C
Our read of incoming data points to some softening in growth momentum from earlier this year. Tension and uncertainty over U.S. – China trade dispute and Brexit, are weighing on the outlook. At the same time, the lagged stimulative effect of recent central bank moves on rate-sensitive areas of the economy appear to be taking hold. The tug-of-war between these forces has led to a neutral near-term tactical weighting between stocks and bonds in CONQUEST portfolios at this time.
Caron, CFA, Senior Portfolio Manager
Chad Morganlander, Senior Portfolio Manager
Matthew Battipaglia, Portfolio Manager
Steve Lerit, CFA, Client Portfolio Manager
Suzanne Ashley, Analyst
WCA Fundamental Conditions Barometer Description: We regularly assess changes in fundamental conditions to help guide near-term asset allocation decisions. The analysis incorporates approximately 30 forward-looking indicators in categories ranging from Credit and Capital Markets to U.S. Economic Conditions and Foreign Conditions. From each category of data, we create three diffusion-style sub-indices that measure the trends in the underlying data. Sustained improvement that is spread across a wide variety of observations will produce index readings above 50 (potentially favoring stocks), while readings below 50 would indicate potential deterioration (potentially favoring bonds). The WCA Fundamental Conditions Index combines the three underlying categories into a single summary measure. This measure can be thought of as a “barometer” for changes in fundamental conditions.
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