U.S. equity markets reached new all-time highs at the end of October. The S&P 500 Index increased 2.0%.(1) Foreign stock markets continued their recent outperformance over U.S. equities as international stocks, measured by MSCI EAFE Net(2), advanced 3.6% last month and the MSCI Emerging Markets Net(2) was up 4.2%.
The Federal Reserve, as expected, cut short term interest rates by 0.25%. Longer term U.S. rates increased by 0.08 – 0.11%.(1) The Barclays U.S. Aggregate Total Return Bond Index (3) increased by +0.3%. German government bond yields became less negative, moving up 16 basis points to -0.41% and Japanese government yields moved up 8 basis points to -0.13%.(1)
There were plenty of reasons to become more optimistic in October. Negative bond yields worldwide became less negative, especially in Germany and Japan.(1) The September unemployment rate was 3.5%(4), the lowest in 50 years. Nearly 74% of the 341 S&P 500 companies that reported earnings during the month beat lowered estimates.(5) Markets traded higher at the end of the month on hopes that the trade war would de-escalate as the U.S. and China announced a partial trade deal at the White House on October 21st. A deal was not actually signed, details were lacking, and both sides said talks would continue. Europe was relieved that it did not have to worry at this time about a “no deal” Brexit after a deal was reached to extend the original October 31 Brexit deadline to January 31, 2020. The Federal Reserve injected more liquidity into the banking system and said it would start purchasing $60 billion in treasury bills monthly and increase daily repo operations to $120 billion per day from $75 billion.
However, an abundance of data shows that the economy continues to slow. The September ISM Manufacturing purchasing managers’ index came in at 47.8%(6), the lowest level since June 2009. A number below 50% indicates a contraction in manufacturing. ISM Non-Manufacturing Index came in at 52.6, down from August at 56.4 and a 3 year low.(7) The Bureau of Labor Statistics (BLS) reported August Job Openings Levels: Total Nonfarm (JOLTS), decreased to 7.051 million, the lowest number of openings since March 2018.(8) Corporate earnings results are down -0.6% on 4.9% higher revenues than one year ago.(5) Companies buying back their own shares has been a major contributor to the rally since 2009. Goldman Sachs analysis warns that they anticipate 2019 stock buybacks will drop 15% in 2019 to $710 billion and continue to drop in 2020. Corporate buybacks currently provide more demand for stocks than any other individual source, including households, mutual funds or exchange traded funds. Buybacks as a percentage of trailing annual free cash flow has historically peaked near the highs of the market, i.e.: 2000, 2008, and 2016.(9) Lastly, the Federal Reserve is still looking at how to fix short term funding market strains, according to Chairman Jerome Powell at his post FOMC rate cut press conference on October 30. “One thing that was surprising about the episode was that liquidity didn’t seem to flow as one might have expected”, said Powell.
In summary, while the U.S. economy is enjoying its longest expansion in American history, we believe that much of the good news very well may be priced into equity markets. The Federal Reserve began injecting massive amounts of liquidity into the banking system and still does not know why there are short term funding issues. Global economic growth continues to slow. We believe the markets have effectively priced in a U.S.-China trade deal despite its tenuous and elusive nature. We are continuing our defensive posture that we adopted when we recently transitioned to “a later cycle approach” in portfolios during the quarterly rebalance. We still have exposure to equity markets should they continue to move higher but will look to shift, if conditions warrant.