Stocks declined for the third straight week while bonds rose, helping smooth out volatility for balanced portfolios. Cyclical sectors led the way on the downside as a string of disappointing U.S. economic data fueled worries that a slowdown in manufacturing will spread to other parts of the U.S. economy. The Purchasing Managers' Index showed that manufacturing activity contracted in September for the second month in a row. The services index also declined but remained in expansion territory. Topping off the data was September's jobs report, which provided some assurance that despite a slowdown in hiring, the labor market remains tight, a positive for consumers and the economy. We believe the mix of slowing economic data and geopolitical risks is likely to result in higher volatility, but fundamentals appear strong enough to remain constructive.
In the Latter Stages of a Bull Market, Get a Compass, Not a Calendar
The change in seasons from summer to fall is predictable – just point to a particular date on the calendar. You will also notice the more subtle changes -- the shorter days, the cooler evenings, and the turning leaves. In the latter stages of the bull market there are also signs of change, but predicting the end of the cycle is not as simple as circling a future date.
This investment season is punctuated by the longest economic expansion in U.S. history and the second-longest and strongest bull market. As these twin cycles age, investors may be looking for signs that the end is near or that a recession is looming. This week’s data show that economic growth is cooling from its hot pace of a year ago. But rather than signaling some future date for the end of the expansion, we think the data suggest that we may remain in the season of a modestly growing economy and bull market for some time. Here’s why.
Data shows an economy moving forward, but at a slower speed
A survey of manufacturing released this week showed a contraction in that sector for the second straight month, and it caused markets to decline 2.5% over a two-day period1. Manufacturing accounts for less than 10% of output and 9% of jobs created. Though manufacturing is a small segment of the economy, its signal value is high because its performance is correlated with a rising and falling economy. Manufacturing is also more vulnerable to trade tensions and slowing global growth than other parts of the economy. However, the weakness in manufacturing does not seem to be having an effect on the broader economy. Data on the much larger service sector, which composes 80% of the economy, shows that it is still expanding, though its pace has slowed in keeping with a modestly growing economy.
The signs of an economy slowing but still growing was also underscored in the jobs-market data released on Friday. The economy created 136,000 in September, a bit short of the 145,000 jobs expected by the markets. Over the course of 2019, the economy has produced an average of 160,000 jobs a month, compared with 223,000 last year. Though lower than last year, this pace of job growth is still higher than the 100,000 jobs-per-month average we think keeps the economy moving forward. More good news is that the weekly data in jobless claims – a leading indicator of the direction of the economy -- is well below historical averages and consistent with a healthy labor market, with no cold snaps in sight in our view. Revisions over the past two months added 45,000 jobs and pushed down the overall unemployment rate to 3.5% from 3.7%, the lowest level in 50 years. A low unemployment rate is in sharp contrast to how previous expansions ended, when the unemployment rate headed upward.
September’s jobs report also showed that wage growth decelerated last month to 2.9% from 3.3% in August. This deceleration is still above the average pace of wage growth of 2.3% over the 10-year expansion. This pace of wage growth shows a labor market that is neither too cold nor too hot. Moreover, this pace suggests a labor market that is strong enough to support consumer spending, the engine of economic growth, but not too strong as to trigger a spike in interest rates that could slow growth.
Moderately growing wages are positive for corporate earnings, as well. Over the last five years, revenue growth has averaged 3.5%, according to FactSet. Wage growth below revenue growth helps keep corporate earnings climbing. While we expect a deceleration of earnings per share from 21% last year to 2% this year, that pace appears strong enough to support rising share prices over time2.
Global challenges add unevenness to the pace of growth, but they aren't changing the direction.
The markets also reacted to a new round of tariffs announced this week. The White House announced tariffs on $7.5 billion in European goods that will take effect on October 18. In addition, the Trump administration plans to raise tariffs to 30% from 25% on $250 billion worth of Chinese goods on October 15.
Accommodative global central-bank policy serves as a ballast against rising trade tensions and slowing global growth for now, in our view. Additionally, we also think that the ill effects of trade uncertainty will eventually be alleviated by a negotiated U.S./China trade deal, though we expect that deal to be long in the making due to the complexity of the issues being discussed. All told, we expect more market volatility ahead, but within normal ranges. Stocks are only 4% down from all-time highs, and there have only been seven days this year with a market swing above 2%, compared with an annual average of 14 days since 1970.
Grab your compass
In the latter stages of a bull market, turning points in the economy are hard to predict and don’t go according to a preset schedule. Working with your financial advisor can help you build an “all-weather” portfolio that can help to weather all types of market cycles. Rather than relying on a calendar and focusing on timing, let your guide be a diversified portfolio, which will act as your compass, to help keep you moving in the right direction over time toward your long-term financial goals.
Sources: 1. Bloomberg stocks represented by the S&P 500, 2. FactSet, S&P 500 consensus estimates
Nela Richardson, PhD
|Dow Jones Industrial Average||26,574||-0.9%||13.9%|
|S&P 500 Index||2,952||-0.3%||17.8%|
|10-yr Treasury Yield||1.53%||-0.15%||-1.16%|
Source: Bloomberg, 10/04/19. Bonds represented by the iShares Core U.S. Aggregate Bond ETF. Past performance does not guarantee future results.
The Week Ahead
Important economic data being released this week include the Producer Price Index (PPI) on Tuesday, inflation readings Thursday, and consumer sentiment Friday. Attention will also turn to trade negotiations as U.S. and China trade representatives are scheduled to meet Thursday and Friday.
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