Market Commentary Q3 2019 - Warning Flags Flying
Updated: Mar 17
Normally investors can depend on economic analysis and forecasts combined with corporate earnings projections to make investment decisions. However, there are times when the psychological and political background has a significant impact on financial markets. This leads to many uncertainties and binary outcomes that paralyze investors. This is one of those times.
…there are times when the psychological and political background has a significant impact on financial markets.
North America has had an extended period of economic growth. Economic data still remains positive. U.S. unemployment is at a historical low, hourly wages are creeping higher, while inflation remains under 2%. U.S. GDP growth is forecast to be in the 2% plus range - hardly a negative projection. Canadian economic data is also on the positive side. Employment and GDP growth are good and recent trade numbers are excellent. Canada continues to benefit from its close association with the U.S. economy.
However, there are negative reports coming from the U.S. manufacturing sector with leading indicators forecasting contraction. However, manufacturing makes up only 10% of the U.S. economy. The U.S. consumer, whose spending dominates the U.S. economy, has yet to change their positive sentiment as the impact of U.S tariffs on China are still forthcoming. This should happen in the next several quarters and will likely be significantly negative.
Looking outside North America, the economic outlook is decidedly clouded. The World Trade Organization (WTO) has sharply reduced its forecast for world economic growth despite almost $17 trillion of government bonds trading with negative yields. In fact, investors in a search for yield have caused some non-investment grade (aka ‘junk’) bonds to trade at negative rates! In Denmark banks are offering negative interest rate mortgages and Swiss banks are charging 0.75% on deposits. Despite these strong monetary measures, Europe is facing the prospect of Germany slipping into recession. The European Union is also threatened by the imminent withdrawal of the U.K. from the Union without a meaningful trade agreement. This is potentially disruptive for both parties.
China, the second largest world economy, is also showing historically low growth numbers…
China, the second largest world economy, is also showing historically low growth numbers -likely the result of its tariff war with the U.S. Japan and Europe are also now operating with negative interest rates. This will negatively impact financial institutions and savers in general.
With economic prospects deteriorating what is the political background and why is it important? Financial and corporate decision makers are influenced by psychology as well as hard facts. To be blunt, the present psychological background has rarely been worse. The list of ongoing things to worry about is long and many future consequences are unknown. This is highlighted by the fact that even though asset prices are near all time highs, there is still a large portion of investors sitting on the sidelines with cash.
U.S. politics is locked in a bitter presidential impeachment battle that has months to go. Hopes for any Republican and Democratic cooperation on a needed and economically stimulative infrastructure investment program is now highly unlikely. The passing of this program would have likely offset any tendency for the U.S. economy to slip into a recession. In the interim the negative impact of the tariff war will begin to bite.
In the rest of the world the political news is not much better. The Middle East is teetering on the brink of all out war with Iran successfully attacking the Saudi oil fields. Iraq is experiencing widespread unrest with numerous civilian casualties. The U.S. withdrawal from Afghanistan and now Syria guarantees more bloodshed and a rise in anti-West factions. Turkey has already begun to attack the Kurds (recent U.S. allies) in Syria. Israel’s recent election didn’t produce a stable government and a third election is imminent. There is no good news from this area in the near term.
Financial markets, particularly equity markets, have embraced the view that the China- U.S. tariff war will be resolved in the upcoming meeting. Why would the Chinese give a major win to Trump to aid with his re-election next year? Expect tariff negotiations to continue with some minor deals but without any real conclusion. In the interim President Trump has threatened to impose tariffs on a number of European Union countries in retaliation for E.U. subsidies given to Airbus for airplane production. The E.U. will likely retaliate and economic costs will escalate.
The political background is decidedly negative and the potential for further deterioration puts markets on thin ice.
The political background is decidedly negative and the potential for further deterioration puts markets on thin ice. It should also be noted that U.S. corporate profit growth has been relatively flat for the last two quarters and could well fall in the third quarter. With numerous predictions of a recession in 2020, North American equity markets may well have been signalling this possibility by running in place for the last six months.
Our answer has been that we employ what we call the “new 60/40 portfolio”.
At Northland Wealth we are recognized as one of the leading family office investors in the world as we access some of the most sought after alternative asset managers and investment solutions. When we are speaking at some of the largest investment events in North America and Europe or with the media, one of the questions we are asked is “how should a family properly allocate capital given the political and economic uncertainty around the world”? Our answer has been that we employ what we call the “new 60/40 portfolio”.
Traditionally, a 60/40 portfolio meant a balanced portfolio that had a 60% exposure to public equities and a 40% weighting to fixed income. Improving upon this approach, we have found that a portfolio with 60% public market exposure combined with a 40% exposure to alternative (and private market) investments can provide an ideal starting point for many families. Public market investments are usually accessed through cost effective ETFs (which invest in liquid stocks/ bonds) and then combined with alternative asset classes such as real estate, private debt and equity, hedge funds and commodities.
Combining liquid public market investments with alternatives (which are less liquid) has better ability to balance risk, return, liquidity, and investment horizon to create more consistent returns than a traditional stock and bond portfolio.
At Northland Wealth we believe that a well-diversified approach to managing a family’s wealth should provide the greatest return for the risks taken.