As we inch closer and closer to the anticipated holiday season, it’s hard not to stop and reconsider what a unique and wonderful year it’s been for the financial markets. Side note, if you have not seen the Christmas movie, It’s a Wonderful Life, stop reading and go watch it now! I promise you, that movie will have a far grander impact on your life than this article.
This article is simply meant to point out the unique position financial markets have entered:
- Record low-unemployment
- Record low interest rates
- Record high equity markets
- Record hostility in D.C. between Democrats and Republicans
- Highly anticipated 2020 Presidential Election
- Unprecedented trade war between U.S. and China: by far the two largest economies in the world
- BREXIT and the lasting impact on Europe
What could go wrong?!?!?
It’s true that there are a number of meaningful unknowns in the market. However, this is generally true for financial markets (we just haven’t always been at record highs!). On the upside, economists have turned increasingly positive on the U.S. economy in the short term. While they have seemingly called for the impending recession for 6 years straight, current data suggests they have a bit more confidence for the future. Economists currently anticipate a 19% chance of recession within 1-year, 32% within 2-years and 43% within 3-years (note that historical averages are 18%, 27% and 36%).
Why are economists feeling more optimistic?
- GDP is currently trending at 2%. Unemployment remains at the lowest levels of our lifetime. This leads to a healthy consumer. Consumer spending ultimately represents 70% of US economy. Roughly 15% of household income is currently being used for debt. This is the lowest percentage since 1980 and means that consumers finally have some disposable income.
- Corporate America strength. Corporate earnings growth is expected to be 6% in the US during 2020. Why? Profitability. Profit margins are in the top decile of historic averages across almost all 10 sectors. S. Corporations can thank the 2017 Trump tax-cut for this gift.
- Interest rates. Currently, 65% of global central banks are expected to hold interest rates at current levels in the near term. 35% of global central banks are expected to cut interest rates in the near-term. That means that 0% are anticipating rate increases in the short term. Put even simpler, interest rates are not going up materially any time soon. In fact, the future markets estimate another 50bps drop over the next 3 years within U.S. rates. This is not only a positive stimulus for economic growth; it also aids in the valuation of stocks.
While these factors truly are core strengths, we do have vulnerabilities:
Government: Trump has changed politics, maybe forever.
During his first few months in office, Trump tweeted 50-60 times per week, on average. He is now averaging 250-260 tweets a week. Every tweet seems to have the potential to change, well, everything! At any given point during any day, Trump can press a button on his phone and send financial markets into a tailspin. It is something that all financial analysts and traders are being forced to accept as a new normal. What we have noticed is that most tweets are ignored by markets; however, tweets related to the trade war have a real impact. While unconventional, this (immediate) market impact is justified, in our opinion, based on the simple truth that the trade war outcome has a considerable impact on the global economy.
Republicans vs. Democrats. The lack of bipartisanship has reached all time levels within both the House and Senate. For the first time on record, 2019 is the only year there is not a single overlapping topic voted as a top five issue between the two parties (i.e. education, healthcare, taxes). Note that as recent as the 80’s and 90’s, most of the top 5 were the same – just in different orders. This leads me to my favorite political quote: “It has been said that democracy is the worst form of government except all those other forms that have been tried from time to time.” - Winston Churchill
What happens in this environment? Either nothing (no tax reform, no healthcare deal, no infrastructure deal) or absolute chaos. If chaos happens (such as the Democrats winning the presidential election and re-taking the senate), we should expect massive unwinding of the corporate tax reform or other key measures that could dramatically affect Wall Street. This is a real risk, especially as we remain in the 9th inning of an economic recovery.
Overall, we acknowledge that we are in a late cycle economic environment and things can change quickly in the late innings. We do believe that most of the key “recession” catalysts are in fairly decent shape. The biggest risk factor at this point, in our eyes, is simply the division and uncertainty in Washington – and volatility in markets. We are expecting this and have positioned our portfolios to handle this.
As always, thank you for your trust.