December 9th  2019

Top Investment Trends Affecting Your Portfolio This Week

Mixed Economic News and Trade War Uncertainty Led to a Flat, but Volatile Week for Stocks

 Stocks dropped sharply on Monday and Tuesday due to weak economic data and President Trump’s threat to impose more tariffs on France, Brazil, and Argentina, and delay the trade deal with China until after the election. Stocks roared back on Friday after the BLS reported a much better than expected jobs report.

 The S&P 500 closed the week higher by 0.16%, while the tech-heavy Nasdaq 100 fell by 0.08%, and the small-cap Russell 2000 increased by 0.65%. International stocks outperformed the S&P 500 -- the MSCI EAFE Index (international ex-US and Canada), appreciated by 0.36%, while the MSCI Emerging Markets rallied by 1.25%. 

 While the stock market was flat this week, the strong employment report lead to a bond market sell-off. The U.S. 10-year Treasury bond yield and the yield curve (3-month minus 10-year U.S. Treasury bond) rose by 0.07%, and 0.12% respectively. The strong jobs report also led to a decline in the “safe havens” -- the U.S. Treasury long-bond (TLT) fell by 1.35% last week, and gold fell by 0.52%. 

The leading sectors of the S&P 500 for the week were Energy (up 1.41%), Consumer Staples (up 1.08%), and Healthcare (up 0.92%). The lagging sectors of the S&P were Industrials (down 1.13%), Consumer Discretionary (down 0.59%), and Technology (down 45%). 

While the Manufacturing Sector Remains Weak, the Unemployment Rate Reached a Fifty-year Low

The ISM Manufacturing Index fell in November to 48.1, which was below economist’s expectation of 49.4. The report was the second weakest since January of 2016 and was the fourth consecutive month below 50, which is the level that indicates a contraction. Also, the critical new orders component of the report fell to 47.2, which matched its lowest reading since April of 2009. The ISM estimates that the reading of 48.1 is consistent with GDP growth of 1.5%. 

The ISM also reported their Non-Manufacturing Index, which fell by 0.8 points to 53.0, and was below analyst’s expectation of 54.5. Unlike the manufacturing sector, the service sector remained above 50, which is expansion mode. Business activity was the weakest component of the index, and it fell by 5.4 points to 51.6, which was its weakest level in a decade.  According to the ISM, the combined November readings for both indexes (manufacturing and services) corresponds to a 1.4% GDP growth.

Early in the week, the S&P 500 dropped by 2.7% because of the disappointing ISM reports and the President's tariff threats. Luckily, on Friday, the BLS reported a much better than expected employment report, which relieved investor’s recessionary concerns. November's nonfarm payrolls grew by 266,000, which was significantly better than analyst’s expectation of 187,000 and the strongest report since January.

Additionally, September and October were revised higher by 41,000 jobs. The unemployment rate fell to 3.5%, which is the lowest since 1969, while wages grew at 3.1%, which was slightly below October’s rate of 3.2%.  The strong job report  should increase consumer confidence and support consumption growth. 

While the November employment report was impressive, jobs are a lagging economic indicator. We remain concerned that any acceleration in the trade war with China would increase economic uncertainty, which could lead to a more significant reduction in capital investment and new hiring.

The trade war with China, which started seventeen months ago, has contributed to a contraction in the global manufacturing sector and a reduction in capital expenditures by corporations. The financial markets rallied this fall on the belief that the pause in the trade war with China and the Fed’s three interest rate hikes would lead to an economic acceleration and an increase in capital investment.

We are concerned that if the “phase one” negotiations are extended until after the election, as President Trump suggested this week, or 15% tariffs are placed on $156 billion of Chinese consumer goods this Sunday, business will again reduce investment and may look to cut costs by reducing labor to deal with the increased economic uncertainty.

We believe that the strong labor report and the S&P’s recent all-time high will embolden the President to take a hard line with China, which may lead to an outcome that the stock market is not prepared for.

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Chart of the Week
Corporate Profits are Disappointing, and Profit Margins are Contracting

 According to Factset, revenue for the S&P 500 will grow at 3.80% this year, while earnings are expected to be flat at ( up 0.10%) due to declining profit margins. Next year, analysts believe that the S&P 500’s earnings will grow by 9.90%, on revenue growth of only 5.5%.

 Although analysts expect that profit margins are poised to rebound sharply next year, it appears that profits as a percent of GDP remain elevated and poised to regress to an average level. Over the past 70 years, corporate profits as a percent of GDP have averaged 6.9%, with a standard deviation of 1.8%. Currently, profits are 8.6% of GDP, which is nearly one standard deviation above average. We believe that the tight labor market and the strong dollar will continue to pressure profit margins.


profit to GDP

Market Outlook
In the short-term (three-months):We believe that the market offers a very poor short-term risk-reward. The President has threatened to implement the 15% tariff on $156 billion of Chinese goods this Sunday if there is no “phase one” trade deal. We believe that the strong jobs report and the stock market's move to an all-time high could embolden the President to take a hardline with the Chinese.
We believe that this event risk gives the stock market an asymmetrical risk-reward – i.e., the highest probability event that there is a phase one deal or the deadline is extended will lead to a small rally, while the low probability tariff increase would lead to a substantial decline. 
​If there is no adverse escalation in the trade war this week, we expect that the favorable seasonality and the dovish Fed (three rate cuts since July and printing $60 billion each month to buy financial assets) should drive stocks higher into the first quarter. From there, an acceleration in the fundamentals will be necessary to fuel further gains. 
In the long-term (more than four years): we continue to believe that the stock market offers a poor long-term risk-reward. Central bank liquidity and not economic fundamentals drove stocks far from their intrinsic value. The market is priced for perfection, and we believe that earnings are poised to disappoint as rising wages, and a strong dollar lead to declining profit margins. Also,  while many investors think that the Fed successfully managed an economic soft landing, we are concerned that since interest rates are already low, the Fed’s brief easing cycle will have a muted impact on economic growth.
  • lmanley
  • December 10, 2019

About the Author

J. Lawrence Manley, Jr., CFA has always had a passion for investing and has been lucky enough to spend nearly 25 years managing investment portfolios for pension funds, endowments and high-net-worth families. In his experience, there are two major obstacles preventing individuals from reaching their investment goals: Wall Street and Human Nature. Manley Capital was founded to overcome these obstacles and partner with clients to achieve their financial goals.