On the Horizon: Still Climbing That Wall of Worry in Q3

Investors always have a laundry list of market-related concerns, but there are typically a few dominant issues that are likely to determine investment activity and results over the coming months.  Chief among that list continues to be global economic growth, negotiations between the United States and China on a trade deal, the actions of the U.S. Federal Reserve, and what might or might not happen in our nation’s capital.  Rejoining our list this quarter is Brexit and the concerns related to the latest deadline in that ongoing situation, along with a rise in Middle East tensions.

Global Economy, China, The Fed, and Brexit: On the Horizon

There are typically some themes, data points, and scheduled events that can reasonably be expected to impact markets. And though unanticipated events always occur, we address some of the more probable or predictable ones below.  We also attempt to gauge what the market may be anticipating given that markets place their bets ahead of actual announcements or resolutions based on what the market believes the likely outcome will be.  Therefore, market reaction is often more a result of how different the actual result was from investors’ predictions.

1. Is recent softness in economic data temporary or a more worrisome signal? A moderation in global economic growth continued into the most recently completed quarter. It remains unclear whether the weakness in economic activity and indicators is simply a fleeting stall or a more worrisome indication. Periods of slower activity over the course of the current economic expansion have so far proven to be temporary, but bond investors across the globe are pricing in a high probability that this time is different.  The yield curve is inverted in the U.S. and an increasing number of countries across the globe are again experiencing negative interest rates.  While the bond market may be expecting the worst, equity markets sit near all-time highs.  The lower rates do play a role in that, but equity investors remain more optimistic than their fixed income brethren.
2. Here we go again – the U.S. and China return to the negotiating table. After tensions between the U.S. and China appeared to be escalating again in August, the countries announced their intention to return to the negotiating table in October.  Markets cheered the news, of course, as this remains one of the primary concerns for world markets.  As encouraged as investors were by the developments, skepticism remains as investors’ hopes have been raised before, only to be dashed.  Slowing economic growth in both the U.S. and China should drive an increased level of urgency and cooperation, but increasing political pressures are likely to act as a powerful counterbalance for both parties.  Each country may be interested in seeing this conflict resolved but will be hypersensitive to appearing to “lose” the trade war.  Striking a balance that allows both countries to claim victory will be no small task.  As noted in prior write-ups, the fact that investors have been disappointed in the past by negotiation attempts should keep investors from getting overly confident this time around.
3. Brexit – is this the FINAL deadline? It has been more than three years since the UK voted to leave the European Union (EU).  Since that historic vote, Brexit (as it has come to be known) has been delayed twice and cost one Prime Minister her job.  The UK, a member of the EU and its predecessor organization the European Economic Community since 1973, would be the first member state to withdraw from the group.  The “divorce” process has proved challenging as the UK and EU have been unable to agree on terms, in particular how to deal with the border between Northern Ireland and the Republic of Ireland.  What happens next?  As of the time of this writing the UK is due to leave the EU on October 31^st, with or without a deal.  There is still the possibility of yet another extension that would push the deadline back to January 31, 2020.  The best case scenario for markets would be if the UK and the EU were able to finally strike a deal.  For investors, another extension would be good for the coming quarter, but may or may not result in a better outcome in the end.  A “no-deal” Brexit would clearly be the worst case scenario, with many (including the UK’s Office for Budget Responsibility) believing it would push the UK into recession.  The negative is that, deal or no-deal, the UK leaving the EU is bound to be disruptive economically for the region.  The optimistic perspective would point out that investors have had more than three years to prepare for this event and given the difficulty the UK has faced, it is likely to discourage other members of the EU from attempting to also withdraw.
4. Will the Fed continue to reverse course? After raising rates nine times since December of 2015, the Fed reversed course in July and again in September by cutting rates.  After signaling earlier in the year that they intended to hold rates steady, they cited continued economic slowing and uncertainty around trade policy as reasons for the recent cuts.  Every rate decision has plenty of dissenters, but the two most recent cuts have sparked particularly spirited debate.  President Trump has weighed in via Twitter assailing Chairman Powell and the Fed for not cutting more aggressively, while many economists have a hard time understanding why a cut is being made at all.  The Fed itself has added to the debate by stating that the cuts are for “insurance” against ongoing risks.  The Fed does seem intent on not signaling future actions, but bond yields indicate that investors are fully expecting additional cuts in the meetings to come.  The coming quarter provides two additional opportunities (October 30^th and December 11^th) for the Fed to make changes.
5. Middle East tensions on the rise. Tensions between the U.S. and Iran have been building since President Trump withdrew the U.S. from a 2015 nuclear deal between Iran and other world powers.  That tension began to escalate in June when Iran appeared to shoot down a U.S. drone.  The U.S. then followed that action by shooting down an Iranian drone in July over the Strait of Hormuz.  Those events, however, pale in comparison to an attack on two Saudi Arabian oil fields in September.  According to media reports, 25 drones and missiles were used in the attack which forced the kingdom to shut down half of its oil production.  The Saudis, along with a number of other intelligence agencies, have strongly suggested Iranian responsibility for the attack.  Military action has not been ruled out and tensions remain high.  The attack caused a major move (albeit temporary) in oil markets but has yet to have a major impact on broader stock and bond markets.  That would likely change should we see any type of major military response.
6. Democrats finally reach breaking point in call for impeachment; now what? A political controversy that could conceivably end in the removal of the President of the United States would normally warrant a higher ranking on our list.  President Trump, however, has been under threat of impeachment for quite some time and while the Democrats in the House can file articles of impeachment, it is the Republican-controlled Senate that will sit in judgment.  A two-thirds majority vote in the Senate would be required to remove the President.  So as long as the Republicans control the Senate and no smoking gun is revealed, it is unlikely that much will come of the filing other than a chance for both sides to do some grandstanding.

The last few quarters, we’ve listed the inversion of the yield curve among things to watch.  It remains something investors should be keenly aware of, but as we’ve detailed in the past an inverted yield curve may occur quite some time before a recession hits.  It may be several quarters or even years before we’ll know if the current inversion was again a good indication of future economic difficulties.

There’s Plenty to Be Positive About!

As we’ve stated before, when valuations are high and returns strong, a list of things to watch is naturally more inclined to focus on potential negatives or things that could disrupt the status quo.  That doesn’t mean that there isn’t plenty to be optimistic about.  Unemployment remains low, lower interest rates mean cheaper financing for businesses and individuals, and the exponential rate at which technology is improving and being harnessed is driving innovation and creating opportunities across the globe.

Contact Brad Swinsburg 404-874-6244 with questions or to learn more about how Smith and Howard Wealth Management serves affluent individuals and their families.

Explore more information on the third quarter of 2019 by visiting these sites:

Market Recap: Third Quarter 2019

Market Outlook: Third Quarter 2019

A Deeper Dive: Third Quarter 2019

Summary: Third Quarter 2019

Unless stated otherwise, any estimates or projections (including performance and risk) given in this presentation are intended to be forward-looking statements. Such estimates are subject to actual known and unknown risks, uncertainties, and other factors that could cause actual results to differ materially from those projected. The securities described within this presentation do not represent all of the securities purchased, sold or recommended for client accounts. The reader should not assume that an investment in such securities was or will be profitable. Past performance does not indicate future results.