November’s Bounty: Trade Progress, Optimism Lift Stocks Higher

My mailbox is stuffed with holiday cards emblazoned with good wishes, well-coiffed children, and neatly wrapped presents. In stark contrast to these perfect pictures, my house in real life looks, well, a little different—ornaments rolling across the floor and hot chocolate stains on the coffee table. There’s a beauty in that messiness, not unlike the markets.

November Highlights

• S&P 500 up over 25% in 2019 through the end of November, rebounding after a large drop last December
• Bond returns were more muted, but still strong
• Manufacturing data began to strengthen, helped by supportive monetary policy and an easing of trade wars

In late 2018, we saw high levels of stock market volatility; trade tensions between the U.S. and China; weakness in the technology sector; and a fair amount of hand-wringing over the Federal Reserve’s march toward higher interest rates.

This year is ending on a decidedly different (perhaps merrier) note, even though political turmoil and other risks persist. According to Goldman Sachs’s Investment Strategy Group, trade-policy uncertainty hit a new high earlier this year, but tensions between the U.S. and China have eased lately. In early December, the two economic powerhouses were hammering out the details of a phase-one deal and discussing a possible delay of planned U.S. tariffs on Chinese-made consumer goods.

Greater optimism around trade has begun to lift critical sectors of the American economy—which decelerated in late 2018 and earlier this year. The U.S. economy is also beginning to reap the benefits of the Federal Reserve’s effort to prolong the current expansion by cutting rates several times this year, or what’s been called a “mid-cycle adjustment” akin to monetary easing in the mid- to late-1990s.

Equity Markets

In November, positive economic news, including a nascent rebound in global manufacturing activity, helped to lift U.S. equities higher for the second straight month. This gain put the broader stock market seemingly on track for a solid double-digit return this year. The S&P 500 Index gained 3.4% on a total return basis last month and rose 25.3% for the year-to-date period.

Here are a couple more highlights from November:

• Small-capitalization stocks (as measured by the Russell 2000 index) outperformed the broader market for the first time in quite a while, gaining 4%. Investor sentiment toward smaller, publicly traded companies has improved lately thanks to optimism surrounding the U.S. economic outlook and Fed rate cuts, which in theory drives down borrowing costs for a sector that tends to rely heavily on debt.
• On a global basis, U.S. equities outperformed once again. Non-U.S. developed markets (as measured by the MSCI Europe, Australasia and Far East Index) eked out a gain of 1% and emerging markets (as measured by the MSCI Emerging Markets Index) were down slightly.

As in October, global equities got a lift from good news on the corporate earnings front. Sales per share for companies in the S&P 500 were largely positive for the third quarter, although earnings per share declined by 2.4% on a year-over-year basis, according to research from Goldman Sachs. Excluding the volatile Energy sector, earnings were flat for the quarter.

Still, the outcome was better than analysts had expected, or feared, for that matter. Indeed, 74% of S&P 500 companies exceeded analyst forecasts, according to Goldman Sachs research.

A similar trend played out in Europe and Japan, where third-quarter earnings per share declined on a year-over-year basis, but still surpassed expectations. Defensive sectors have recently outperformed cyclical sectors in both Europe and Japan. That trend could reverse itself, however, if global manufacturing activity continues to pick up amid progress on trade talks, as some 20% of Japan’s exports go to China.

U.S. Sectors

As fears of an impending recession faded in November, investors shifted out of some defensive sectors that have performed well and into certain cyclically oriented sectors.

Technology, Financials, and Industrials, for instance, were among the top performers in November. Meanwhile, Utilities and Real Estate, which have enjoyed strong gains this year, suffered losses last month.

For the year-to-date and trailing, 12-month periods through November, Technology was the clear leader, returning almost 42% and nearly 30%, respectively. The sector has been on a tear this year despite greater regulatory scrutiny and a handful of disappointing, high-profile initial public offerings (IPOs).

Fixed Income

As in October, bonds saw muted returns last month as investors gravitated toward riskier assets. The Bloomberg Barclays U.S. Aggregate Bond Index, a closely watched benchmark of the domestic fixed-income market, suffered a slight loss in November.

Despite the setback, the bond market was still up nearly 9% and almost 11% for the year-to-date and trailing, 12-month periods through last month. Corporate bonds, longer-dated Treasurys, and high-yield bonds had solid, double-digit returns for the year-to-date through November.

Bonds have begun to fade from the spotlight in more ways than one. Just a few months ago, many investors were alarmed by yet another yield-curve inversion—a bond-market phenomenon that has been a reliable, yet early, recession indicator.

The yield curve measures the difference between current interest rates on short-term and long-term government bonds. It inverts when the rates on long-term bonds fall below those of short-term bonds, a sign that investors expect slower economic growth, interest rate cuts, or both. Longer-dated bonds (like 10- and 30-year Treasurys) typically have much higher yields than shorter-dated bonds since investors expect to earn more in exchange for locking up their money for lengthy periods.

Since October, a number of factors have combined to push long-term Treasury yields higher, and thus the yield curve has returned to normal (as of early December), which has helped to quiet concerns about the near-term economic outlook.

The Economy and the Fed

We’re seeing signs that the Fed’s rate cuts—and incremental progress on the trade front—are beginning to filter through to the broader economy. For instance:

• IHS Markit reports that its purchasing managers’ index (PMI) climbed to 52.2 in November, the fastest rate of growth since April. PMI readings above 50 indicate expansion, while those below signal contraction. Manufacturing PMIs in many countries weakened this year, but, with a few exceptions, have been showing signs of a turnaround, according to Goldman Sachs.
• Housing, an interest-rate sensitive area of the economy, is also showing signs of improvement. Last month, the Commerce Department reported that the issuance of housing permits—a leading indicator of housing construction—hit its highest level in more than a decade.

The U.S. economy produced a greater-than-expected 266,000 new jobs in November, and the unemployment rate stood at a 50-year low of 3.5%, which demonstrates the resilience of the labor market in the face of lingering trade uncertainty, the U.S. presidential impeachment proceedings, and other headwinds.

With the holidays bringing some cheerful economic news, the Fed has signaled that it’s done with its so-called mid-cycle adjustment. Indeed, the central bank left interest rates unchanged following its two-day meeting in early December.

In prepared remarks delivered last month, Fed Vice Chair Richard Clarida said: “The economy is in a good place, and monetary policy is in a good place.”

Conclusion

While the market was in a celebratory mood at the start of the holiday season, it’s important to remember that, much like my kids after a few too many candy canes, the market can be fickle. A festive mood can quickly sour—as we’ve seen this year when stocks bounced around with each twist and turn of the trade war. Whether during the holidays or not, a sense of gratitude can go a long way toward helping us keep things in perspective.

On that topic, I want to thank you for entrusting us with your investments. I and the rest of the Investment team here at United Capital take the responsibility very seriously and are grateful for our partnership.

Live richly and invest well,

Kara Murphy, CFA^®

Chief Investment Officer

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Index Definitions

S&P 500 Index: A broad-based measurement of changes in stock market conditions based on the average performance of 500 widely held common stocks. It is a capitalization-weighted, unmanaged index that is calculated on a total return basis with dividends reinvested. The S&P 500 represents about 75% of the NYSE market capitalization.

Russell 2000 Index: This index measures the performance of approximately 2,000 small-cap companies in the Russell 3000 Index, which is made up of 3,000 of the biggest U.S. stocks; the index serves as a benchmark for small-cap U.S. stocks.

MSCI Europe, Australasia, and Far East (EAFE) Index: This index is a free float-adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the U.S. and Canada.

MSCI Emerging Markets Index: This index is a free float-adjusted market capitalization index that is designed to measure equity market performance of emerging markets. As of June 2009, the MSCI Emerging Markets Index consisted of the following 22 emerging market country indices: Brazil, Chile, China, Colombia, Czech Republic, Egypt, Hungary, India, Indonesia, Israel, Korea, Malaysia, Mexico, Morocco, Peru, Philippines, Poland, Russia, South Africa, Taiwan, Thailand, and Turkey.

Bloomberg Barclays U.S. Aggregate Bond Index: This is a market capitalization weighted bond index of investment-grade, USD-denominated fixed-income securities.

U.S. High Yield Corporate: The Bloomberg Barclays U.S. Corporate High Yield Bond Index measures the USD-denominated, high-yield, fixed-rate corporate bond market. Securities are classified as high yield if the middle rating of Moody's, Fitch, and S&P is Ba1/BB+/BB+ or below. Bonds from issuers with an emerging markets country of risk, based on Barclays EM country definition, are excluded.

U.S. Investment Grade Corporate: The Bloomberg Barclays U.S. Corporate Bond Index measures the investment-grade, fixed-rate, taxable corporate bond market. It includes USD-denominated securities publicly issued by U.S. and non-U.S. industrial, utility, and financial issuers.

Bloomberg Barclays Municipal Bond Index: The Bloomberg Barclays U.S. Municipal Index covers the USD-denominated, long-term, tax-exempt bond market. The index has four main sectors: state and local general obligation bonds, revenue bonds, insured bonds, and pre-refunded bonds.

S&P 500 GICS Sectors Level-1: In 1999, MSCI and S&P Global developed the Global Industry Classification Standard (GICS) to offer an efficient investment tool to capture the breadth, depth, and evolution of industry sectors. GICS is a four-tiered, hierarchical industry classification system. It consists of 11 sectors, 24 industry groups, 68 industries, and 157 sub-industries. Companies are classified quantitatively and qualitatively. Each company is assigned a single GICS classification at the sub-industry level according to its principal business activity. MSCI and S&P Global use revenues as a key factor in determining a firm’s principal business activity. Earnings and market perception, however, are also recognized as important and relevant information for classification purposes and are considered during the annual review process.

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