supposed to be a slow, relaxing month — but this August was anything but that
for investors. Trade frictions were on the rise for much of the month. The US
Treasury yield curve inverted several times, causing jitters for investors
concerned that a US recession is imminent. Of course, stock volatility rose,
with the CBOE Volatility Index (VIX) hitting its highest level of 2019 in the
month of August.1 Instead of enjoying calm, sunny days, markets were
rocked last month by interviews with Federal Open Market Committee (FOMC) members
at Jackson Hole, tweets from President Donald Trump, and geopolitical events in
the UK, Italy and India — to name just a few.
result, much of August saw a “risk off” sentiment, with investors crowding into
“safe haven” asset classes such as Treasuries and gold. However, a more dovish
Federal Reserve has provided some support to risk assets, and so the S&P
500 Index finished August higher than where it began despite a bumpy ride. August
provided us all with a reminder of the potential benefits of diversification —
and the importance of ignoring the noise and staying invested.
What to watch in September
- Brexit. The Brexit chaos is likely to
intensify this week as a showdown seems imminent. UK Prime Minister Boris
Johnson appears hellbent on leaving the European Union (EU) on Oct. 31 and has
done everything he can to ensure that outcome. Last week, Johnson went so far
as to suspend Parliament for five weeks between mid-September and mid-October, greatly
limiting the amount of time Parliament has to stop a “no-deal” Brexit. Members
of Parliament who oppose a no-deal Brexit are trying to pull together and
coordinate a “no confidence” vote or a change to the law to prevent Britain
from withdrawing from the bloc without an exit deal. Lawsuits have also been
filed to prevent a no-deal Brexit and are making their way through the courts. And,
as I write this, a Tory member of Parliament has just resigned, removing
Johnson’s majority and adding to the uncertainty around events in the UK this
week. Economic policy uncertainty is likely to rise even more, which could negatively
affect business investment, and the pound is likely to remain under pressure.
- The impact of US-China tariff wars. More US tariffs
have gone into effect as of Sept. 1, mostly affecting consumer goods from China.
And while market sentiment around the US-China trade relationship grew more
positive last week, sentiment has reverted to a more realistic position this
week. After all, if the US and China are having difficulty deciding on which
dates to hold talks this month, it doesn’t seem like an agreement is imminent,
to say the least. The trade wars have been negatively impacting US
manufacturing, and that was evidenced in the Sept. 3 release of the US ISM
Manufacturing Index, which clocked in at 49.1 for August — indicating the
manufacturing sector is in contraction. The ISM Manufacturing New Orders
sub-index, which I follow closely, dropped precipitously in August to a
seven-year low. The new tariffs will likely weigh on US consumers as well — and
we’ve just begun to see signs of consumer weakness. The August University of
Michigan Consumer Sentiment Index posted its largest drop in six years. But I
am even more concerned about the consumer expectations gap, which is showing a
growing divide between current conditions and consumers’ expectations for the
future. Both measures are dropping, but expectations have fallen approximately
double what current conditions have fallen in the last month.2 We
will want to monitor US economic data closely, especially as it relates to the
- The yield
curve. In my view, the 2-year/10-year Treasury yield curve seems likely
to invert yet again. However, while I expect economic growth in the US to slow,
I don’t believe a recession is imminent. A US recession is not a foregone
conclusion, but it could easily happen if the trade conflict continues on its
current path. As I have said for some time, tariff wars are not good and they
are not easy to win. I believe China is in a far better bargaining position
than the US; I don’t see any compelling reason why China would capitulate. My base
case remains that the trade conflict will not be resolved in the shorter term,
but as we approach the 2020 US presidential election, I see an increasing
probability that the US will capitulate and take minor concessions from China
in order to strike a trade deal.
- Italy. After the collapse of the previous
coalition government between the Five Star Movement and the Lega Party, a new
coalition government between the Five Star Movement and the center-left Democratic Party (PD) is
in the process of being formed. The yield on 10-year Italian government bonds has
fallen to 0.865% from 1.80% just three weeks ago,3 clearly
indicating relief and confidence in the new coalition government. But a
likely coalition does not mean the turbulence will end. Five Star party members
must still approve the deal. And
then the new government will need to agree on a new
budget that will be in accord with the two parties’ critical values and
hopefully stimulate Italy’s lackluster economy. The two parties will also need
to divvy up the key cabinet posts, which could easily lead to discord. One bright spot is that the PD is pro-European Union (the
Lega party was not), which suggests there is less potential for acrimony with
- The Fed. The next FOMC meeting is just a few
weeks away. I do think we will get a rate cut in September, but I am not sure
about any other rate cuts. That’s particularly so after hearing from several
FOMC members interviewed at Jackson Hole, who made it clear they are reluctant
to cut rates again if they can avoid it. I expect the Fed to be data dependent — and trade
war news dependent. In any event, Fed easing can’t provide an antidote to
tariffs. In my view, the biggest impact Fed accommodation will have will be on
stocks and other risk assets.
In conclusion, there is a lot happening in September, just as
there was a lot happening in August. Investors should try to avoid the noise
and not panic. Stay very well-diversified and maintain exposure to risk assets,
but also have adequate exposure to alternative asset classes. And keep an eye
out for buying opportunities, which can often present themselves in periods of
1 Source: Bloomberg, as of Aug. 31, 2019
2 Source: University of Michigan Surveys of Consumers, as of Aug.
31, 2019 (released Sept. 3, 2019)
3 Source: Bloomberg, as of Sept. 3, 2019.
Blog header image: Marilar Irastorza/Stocksy
Diversification does not guarantee a profit or
eliminate the risk of loss.
The Federal Open Market Committee (FOMC) is a
12-member committee of the Federal Reserve Board that meets regularly to set
monetary policy, including the interest rates that are charged to banks.
An inverted yield curve is one in which
shorter-term bonds have a higher yield than longer-term bonds of the same
credit quality. In a normal yield curve, longer-term bonds have a higher yield.
The CBOE Volatility Index® (VIX®) is a key measure of market
expectations of near-term volatility conveyed by S&P 500 stock index option
prices. VIX is the ticker symbol for the Chicago Board Options Exchange (CBOE)
Volatility Index, which shows the market’s expectation of 30-day volatility.
Risk off refers to price behavior driven by
changes in investor risk tolerance; investors tend toward lower-risk
investments when they perceive risk as high.
Safe havens are investments that are expected to hold
or increase their value in volatile markets.
Risk assets are generally described as
any financial security or instrument, such as equities, commodities, high-yield
bonds, and other financial products that carry risk and are likely to fluctuate
The S&P 500® Index is an unmanaged index considered
representative of the US stock market.
Brexit refers to the scheduled exit of the UK
from the European Union. In a “no-deal” Brexit, the UK would leave the EU with
no formal agreement outlining the terms of their relationship.
Manufacturing Index, which is based on Institute of Supply Management surveys
of more than 300 manufacturing firms, monitors employment, production
inventories, new orders and supplier deliveries.
The ISM Manufacturing New Orders Index, which is based on
Institute of Supply Management surveys of manufacturing firms, monitors the
level of new orders across several industries in the manufacturing sector.
The University of Michigan
Consumer Sentiment Index tracks US consumer confidence levels on a monthly
Alternative products typically hold more
non-traditional investments and employ more complex trading strategies,
including hedging and leveraging through derivatives, short selling and
opportunistic strategies that change with market conditions. Investors considering
alternatives should be aware of their unique characteristics and additional
risks from the strategies they use. Like all investments, performance will
fluctuate. You can lose money.
The opinions referenced above are those of the
author as of Sept. 3, 2019. These
comments should not be construed as recommendations, but as an illustration of
broader themes. Forward-looking statements are not guarantees of future
results. They involve risks, uncertainties and assumptions; there can be no
assurance that actual results will not differ materially from expectations.