The single greatest edge an investor can have is a long-term orientation. – Seth Klarman
In the face of continued trade uncertainty with China and renewed recession fears, the major stock averages rallied last week for their best performance since June. The S&P 500 Index rose nearly 3% as China announced that it would not retaliate against the U.S. in the latest round of tariffs and was opposed to escalating the trade war. Despite the strong gains for the week, though, stocks posted losses for the month of August with the S&P 500 down almost 2% and the technology-laden Nasdaq Composite Index down over 2.5%. It was still encouraging to finish the month on a positive note as recent sentiment had turned decidedly negative on increased trade tensions and recession worries. When it comes to the ongoing trade war, it’s difficult to know which side to believe. According to the White House, Chinese officials had called the U.S. and said that they were ready to return to the negotiating table. But Chinese officials denied that any call had been placed. What is certain is that the first stage of U.S. tariffs on $300 billion worth of Chinese goods is set to be imposed on September 1st with China set to implement its own tariffs on the same day. The direct result of this trade war has been a deteriorating short-term economic outlook that has led many to believe that a recession could be around the corner. Treasury yields have plunged across the yield curve with the 2-year Treasury and the 10-year Treasury yielding just 1.50% and the 30-year Treasury below 2% at only 1.96%. The drop in yields was in response to slowing economic growth both here and abroad as well as a lack of inflation. The difference between the 2-year and 10-year Treasuries had been negative earlier in the week, a relationship known as an inverted yield curve and typically a reliable predictor of a recession. Second quarter growth was revised slightly lower last week to 2.0%, but GDP growth should remain positive for the balance of the year. While the four most dangerous words in investing are “this time is different”, the fact that about $16 trillion in bonds around the world have negative yields may be creating strong demand for U.S. bonds and, as a result, causing yields to decline. (Bond prices and yields move in opposite directions).
Durable goods orders rose modestly in July and were better than expected, although the manufacturing sector continues to be weak due to trade tensions, global weakness and a strong dollar. U.S. consumer spending in July was better than expected and the core personal consumption expenditures (PCE) index, the Federal Reserve’s preferred inflation gauge, rose slightly and was in line with estimates. The year-over-year price gain has been only 1.4%, well short of the Fed’s target of 2%. Both the University of Michigan consumer sentiment index and the U.S. consumer confidence index fell in August and were less than expected as trade uncertainty and recession fears made consumers less confident about the future. Weekly jobless claims rose by 4,000 to 215,000, in line with estimates, as layoffs remain low.
For the week, the Dow Jones Industrial Average gained 3% to close at 26,403 and the S&P 500 Index added 2.8% to close at 2,926. The Nasdaq Composite Index jumped 2.7% to close at 7,962.
The most important piece of economic data this week is the August employment report, which is expected to show that about 157,000 new jobs were created and that the unemployment rate remains at 3.7%. Both July construction spending and factory orders should be better than they were in June while the August ISM manufacturing index and non-manufacturing or services sector index are forecast to be about even with the previous month and still in expansion territory.
As earnings season winds down, the most prominent companies scheduled to report this week include Palo Alto Networks, Ciena, American Eagle Outfitters, Vera Bradley, Navistar International and Korn Ferry.
If investors were disappointed with the equity performance in August, the month of September may not be any better. Historically, the month of September has been the worst month of the year and the only month that is down more often than it is up. In fact, stock market returns in September have been negative over half of the time. Volatility in the financial markets is likely to continue as trade wars and tariffs have caused additional uncertainty about the outlook for the economy and have increased the possibility of a recession. No progress has been made in the trade war with China and there does not appear to be any resolution in sight. While it may be tempting for investors to sell their equity positions in order to time the market, no one has ever devised a plan to move in and out of the market successfully. One study has shown that in the 10-year period ending in January 2017, an investor in the S&P 500 Index who missed the 10 best trading days would have gained only about 14% during the decade. But an investor who remained invested in the S&P 500 Index for the entire time, including the 10 worst trading days for that period, would have realized a gain of 58%. Although an inverted yield curve may portend a recession, the actual onset of the recession may not occur for between 7 and 20 months. During this time, stocks have often performed very well, proving that investors should maintain their investment objective and stick with their asset allocation, especially for those investors with a longer time horizon. Trying to time the market is risky and a fool’s errand as it is next to impossible to know when to sell stocks and get out of the market and when to buy stocks and get back into the market. As the late John Bogle said, the idea that a bell rings to signal when investors should get into or out of the market is simply not credible.