Weekly Market Update (September 9 – September 13, 2019)

By Craig Fehr September 13, 2019

Improving economic data, supportive global central-bank policies, and optimism around trade all led stocks to advance near record highs. China announced that it would exempt some U.S. products from tariffs, and the U.S. responded with delaying the increase in some of the tariffs scheduled to take effect next month. These goodwill gestures from both sides sparked optimism that an interim trade agreement can be achieved. Notable market moves last week include a sizable rise in Treasury yields and the outperformance of cyclical sectors (financials, industrials, energy) over defensives (utilities, health care, staples). Another shift was the preference for stocks with depressed valuations over stocks that traditionally trade at higher price-to-earnings ratios, which have outperformed this year. While the timing of swings in the market's complexion and leadership rotation are hard to predict, well-diversified portfolios can provide exposure to future asset-class leaders and potentially smooth out the ride for investors.


Brexit 2.0


Brexit 2.0 – The Next Spark?

Equities posted another strong week, bringing the U.S. stock market back to within 1% of all-time highs set in late July1.  After a rocky patch in August, some optimism has returned as
  • Economic data, including the latest readings on the jobs market and retail sales, helped quell fears of a looming recession;
  • Trade tensions have simmered from a boil, with tariff postponements and President Trump commenting last week that he'd potentially be open to incremental agreements with China as a larger trade deal is pursued; and
  • Interest rates have rebounded, calming concerns that the plunging yields and the inverted yield curve were signaling imminent economic distress. 

We're not surprised by the stock market's rebound from the August pullback -- it's consistent with our ongoing view that equities will see more frequent bouts of volatility at this stage in the cycle, but that the fundamental backdrop is still supportive of an extension to this bull market.  Cooler heads have prevailed in September, but the sparks that will ignite the aforementioned bouts of volatility have not been extinguished in our view. 

  • The Fed is likely to cut rates this week, but we expect markets will respond to any signals that additional policy moves aren't in sync with current expectations for more rate cuts.
  • In addition, despite last week's signs of progress, we don't expect the trade situation with China to be resolved any time soon, keeping markets on edge.
  • Meanwhile, though a bit more under the radar, the unfolding Brexit issue is likely to capture more attention ahead.

Brexit 2.0 – More About Politics Than Portfolios

  1. Brexit recap - In June of 2016, Britons voted for the U.K. to leave the European Union – a political and economic union that allows for free movement of people, money and trade among its 28 member nations. Markets dropped sharply in response to this unprecedented mandate, falling more than 5% over the next two days1. While the market reaction was immediate, the actual exit date has been delayed multiple times in an effort to strike a deal between the U.K. and the EU that would allow for a more orderly separation. Flash forward to today. After years of unsuccessful negotiations for an exit deal, the new prime minister, Boris Johnson, has taken the stance that the U.K. will leave by the approaching deadline, October 31, with or without a deal.

  2. Politics are unpredictable – Britain's primary political parties, (the Conservative and Labour parties) are at odds on how Brexit should proceed. At the center of the issue is how to handle the border between Ireland (in the EU) and Northern Ireland (part of the U.K.). Provisions for this "Irish Backstop." as it's known, have been a sticking point in the negotiations, which has resulted in Parliament being suspended and U.K. lawmakers scrambling to pass legislation that requires an extension to the October 31 deadline if a Brexit deal is not struck in the coming weeks.  The potential for a snap Parliamentary election to be called further clouds the outlook given the uncertainty of where the political power may ultimately land. Structuring an amicable divorce between the U.K. and EU was already wrought with ambiguity. The political disarray in Parliament only adds to the uncertainty. Given the market's disdain for uncertainty, this raises the potential for Brexit to stoke market swings ahead.   

  3. Investment implications – Brexit poses significant social, political and economic challenges. Severing more than 45 years of immigration and trade ties without an organized, gradual agreement for doing so threatens meaningful disruptions to the U.K. A "no-deal exit" (known as a "hard" Brexit) would mean British trade with Europe (Britain's most critical source of exports and investment) could face customs delays and supply-chain dislocations.  That said, we'd offer three broad takeaways for investors:
    1. A hard Brexit is far from assured at this stage. While Prime Minister Johnson has taken a hard line on the exit, we wouldn't rule out his willingness to negotiate a softer withdrawal as he faces significant political and economic pressure. A delay in the deadline (to provide breathing room to facilitate a deal) or some form of a deal itself in the coming weeks could go a long way to lessening the blunt economic impact of the U.K.'s withdrawal, giving it time to address security, immigration policies and trade agreements.
    2. The U.K. accounts for just over 3% of global GDP, less than the GDP of California. So while these challenges are significant from both a social and financial standpoint, a slowdown in the U.K. economy won't lead a global downturn. Further, U.K. GDP growth averaged 2.5% in the three years before the Brexit vote, and has averaged 1.6% since, meaning a portion of the negative economic impact has likely already shown up, as Brexit uncertainty has reduced domestic investment.  While a hard Brexit-induced recession in the U.K. is not unrealistic, the U.K. controls its own currency (pound sterling) and its central-bank policy rate is above zero, leaving scope for monetary policy stimulus, if necessary. 
    3. Global stock markets won't be immune to any Brexit turmoil, but the more sustained drivers of market performance will come from U.S./global economic growth, corporate profits and Fed/ECB monetary policy actions, all of which are still reasonably supportive, in our view.  Heading into the surprise Brexit vote outcome in 2016, the stock market was just 0.7% below its all-time high (similar to today), with stocks having risen more than 9% in the preceding four months (stocks are currently up 9% over the past four months)1.  2016's Brexit decline was recovered within a week. The Brexit vote and the actual exit are different, as are global economic and policy conditions today, but we think investors should expect potential Brexit-driven volatility, not exit the market or shift strategies because of it. 

Craig Fehr, CFA

Investment Strategist

Sources: 1. Bloomberg, S&P 500.

Index Close Week YTD
Dow Jones Industrial Average 27,220 1.6% 16.7%
S&P 500 Index 3,007 1.0% 20.0%
NASDAQ 8,177

0.9%

23.2%

MSCI EAFE* 1,919.61 2.0% 11.6%
10-yr Treasury Yield 1.90% 0.34% -0.78%
Oil ($/bbl) $54.94 -2.8% 21.0%

Bonds

$111.75 -1.7% 7.0%

Source: Bloomberg, 09/13/19. *5-day performance ending Friday. Bonds represented by the iShares Core U.S. Aggregate Bond ETF. Past performance does not guarantee future results.


The Week Ahead

The spotlight this week will be on the Federal Reserve as it announces its rate decision on Wednesday. Other important economic data being released include housing starts on Wednesday and existing home sales, along with the leading economic index, on Friday.

Review last week's weekly market update.

Important Information

The Weekly Market Update is published every Friday, after U.S. markets close.

The Dow Jones Indexes are proprietary to and distributed by Dow Jones & Company, Inc. and have been licensed for use.

All content of the Dow Jones Indexes © 2017 is proprietary to Dow Jones & Company, Inc.

The Dow Jones, S&P 500 and Barclays Aggregate Bond Indexes are unmanaged and are not meant to depict an actual investment.

Past performance does not guarantee future results.

Diversification does not guarantee a profit or protect against loss.

Investors should understand the risks involved of owning investments, including interest rate risk, credit risk and market risk. The value of investments fluctuates and investors can lose some or all of their principal.

Special risks are inherent to international investing, including those related to currency fluctuations and foreign political and economic events.

This information is approved for use with the public.

It is intended for informational purposes only.

It is believed to be reliable, but its accuracy and completeness are not guaranteed.

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