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.