'Tis strange -- but true; for truth is always strange; Stranger than fiction…
- Lord Byron’s Don Juan (1823)
These are strange and unsettled times in many ways. Yet no one appears to have told the stock market: the blended global stock index1 is up 18.71% this year through 9/30 and 6.78% in the third quarter. It’s the best performance for US stocks in the first three quarters in 47 years.
The Federal Reserve chairman assures us the economy is in great shape while the three most recognized recession indicators are each flashing red. The Leading Economic Index (LEI) is negative and fell again last month. Unemployment has risen enough to set off the “Sahm Rule” recession indicator2. And as we’ve noted before, the “yield curve” – the difference between the yields of 10-year Treasury and 3-month Treasury obligations – remains negative.
Not to worry, rejoins the market: the Fed’s monetary policy has been just restrictive enough to bring down inflation but not so stringent as to cause a recession. The elusive “soft landing” has been achieved in the market’s judgment, and the prospect of recession is now off the table since the Fed is cutting interest rates again.
History suggests such a soft landing is a rare accomplishment. In the last 60 years, only one Fed tightening cycle failed to bring a recession. Moreover, that one exception was in 1994, which some of us remember was not a fun year to own either stocks or bonds.
The Fed’s well-telegraphed interest rate cut last month was unsurprising. Less expected was its size: a cut of 0.50% rather than the much more typical 0.25%. The question looms: did that move reflect confidence about inflation or concern about employment?
“Don’t Fight the Fed” may be the most widely held perception of market wisdom, so markets cheered. But this fact might mute the celebration: In the past 50 years, only five interest-cutting cycles began with a cut of more than 0.25%. In four of those, a recession was soon identified – one had already begun but was not yet declared, and in the other three, a recession soon followed. Yes, that’s a tiny sample. But one out of five is not good odds for avoiding a recession.
Per a recent survey, more Americans are looking for work now than in the past decade and employment worries are also at their highest level in ten years. Foreclosures and bankruptcies in commercial real estate loans are up. Delinquencies for both credit card loans and auto loans increased in September. And Brian Westbury of First Trust recently noted that in the past year, 82% of net new jobs have been either in government, education, or healthcare – not indicative of a robust economy.
Sharing this does not mean we’re forecasting a recession. We aren’t. Jobless claims just fell to their lowest level in four months. Retail sales grew 2.1% year-over-year in August, and the July estimate was just revised significantly upward.
The consensus calls for continued, but slower, economic growth. That seems reasonable to us as the most likely outcome, and second-quarter GDP was a solid 3.0%. But we do recognize risks to the downside here and we fear those may be inadequately discounted into stock prices.
The outlook for the international economy brightened in late September as China initiated a massive, multi-prong stimulus and the European Central Bank cut interest rates as well.
Headline CPI inflation continues to improve, coming in at 2.5% annual growth in the latest release and giving the Fed cover for the rate cut. But “core” CPI (ex-food and energy) grew at a concerning 3.3% rate, so we’re not out of the inflation woods yet. If protracted, a dockworker’s strike in The Gulf and the East Coast could add to pricing pressures. And as if you haven’t noticed: Geopolitical tensions remain elevated.
With all these crosscurrents, what do people want to discuss? Politics! Specifically: What will the election mean to markets?
Here, history tells a more soothing tale as Presidential elections have not been as important to markets as most think. With the sole exception of the 2001-2009 term of George W. Bush (which included both a recession in 2001 and the “Great Recession” of 2007-2009 and experienced an 8-year return for stocks of -4.5% per year3), all other presidential terms since Carter’s saw healthy stock market returns for the full four or eight-year presidential terms. Moreover, other than the George W. Bush exception just mentioned, there was remarkably little difference in the stock returns between any of the full terms, regardless of political party.
Shorter-term, markets can be volatile in October of election years as uncertainties loom. But after the election is resolved (which may not be November 3 if it’s close and some states count slowly), markets tend to be strong through the end of the year regardless of the winning party.
Also unlikely to be affected by who wins in November is the Federal Debt, which just surpassed $35 Trillion, as neither candidate prioritizes even slowing its growth. With the US GDP estimated at just under $29 Trillion, that means federal debt exceeds 120% of GDP now. More on this in future comments, but that’s not a good long-term development and it increases the longer-term likelihood of lower economic growth, lower prospective stock returns, and higher inflation.
After lagging Growth stocks in the first half, Value stocks significantly outperformed in the third quarter, closing about half of their year-to-date gap. An overdue market turn toward long-term norms is welcome and encouraging.
A disciplined and highly diversified investment approach is unlikely to avoid losses in the next market correction, whenever it may arrive, but we would expect it to generally fare better than broad stock indexes in such a circumstance. On the other hand, should the economy continue to avoid a decline, and markets remain elevated, such a conservatively yet fully invested approach should prosper as well. That’s about as much as we can ask for in a world that’s increasingly stranger than fiction.
1 The blended global stock index is 70% Russell 3000 (total) of the US stock index and 30% of the MSCI ACWI ex-US Index.
2 Per the Sahm Rule, a recession is signaled when the three-month average in unemployment rises 0.5% or more above its lowest point in the prior twelve months.
3 It should also be noted that the George W. Bush presidency began as the Tech Bubble of the late 1990s was unwinding. At the market peak, big-cap Tech market leaders were extremely expensive. In fact, the only other time to rival that for extended valuations and concentrated markets has been … now.