By Alan Ahmatovic
Just as the Green Day song goes, “wake me up when September ends!” In case you’re unfamiliar, here is a quick link to the song for some context (Youtube Link). It wasn’t just Apriem that felt this late summer lull, as investors across the globe faced lower returns and higher volatility. Some sectors in the market produced positive returns while others came in negative, effectively neutralizing the overall market’s performance, which left the S&P 500 returning a modest half a percent. With so much red and green on the screen, you’d think it’s Christmas! Unfortunately, we still have three months to go before the holidays and markets are expected to face continued uncertainty for the remainder of 2018. However, if there’s one thing that’s not uncertain, it’s the strength of the U.S. economy. All relevant economic numbers continue to look robust, leading many investors and economists to predict little chance of a near-term recession. With so much strength in the economy, the market’s concern has turned to it overheating, just as a bucket of water will overflow when faced with no resistance. In response to this, the U.S. Federal Reserve raised interest rates again in September, which can be thought of as punching tiny holes in this bucket.
To further illustrate this analogy, if water is the flow of money, brought on by increased production and job growth, then each tiny hole in the bucket is an interest rate hike, effectively increasing the cost of money. Essentially, the Fed’s goal is to keep the faucet running smoothly, while preventing the bucket from overflowing, creating a steady and sustainable flow of water, aka a healthy durable economy. With the Fed dead set on continuing to push rates higher, the market has begun to follow suit, which has been reflected in the recent steepening of the yield curve, a visual representation of the markets views on current and future interest rates. This means the market expects economic growth and inflation to continue to move higher. So, one may ask, why does this hurt the stock market? While it’s not necessarily bad, it just means higher rates will eventually lead to a slow down, just like the eventual tempered flow of water in our bucket analogy, which can sometimes be difficult for the markets to digest. Given these dynamics, many investors have adopted the view that further volatility will simply lead to attractive buying opportunities.
Trade, trade and more trade! This five-letter word continues to dominant the headlines when it comes to international markets. There were some market moving developments in September that were both good and bad for the current trade war dilemma. The U.S. slapped another $200 billion worth of tariffs on Chinese goods, which was met with an instant retaliation by China. Just as it looks, there continues to be more and more tariffs and less and less talks. These fears have continued to weigh on international markets, while simultaneously leading to strength in the U.S. dollar, since many international economies may face weaker prospects due to this global trade dilemma. The positive news was restrained to North America, after the U.S., Mexico and Canada formed a new trade agreement coined the USMCA. For many reasons, the agreement is very similar to the original NAFTA, leading to the nickname of NAFTA 2.0. One vital difference is the emphasis on increasing manufacturing investment in the U.S., in an effort to reduce the trade deficit between the U.S. and Mexico, a heavy agenda item for President Trump’s administration. As it stands, this is a clear win for Trump, although the treaty may face lengthy negotiations before it passes through the Senate. Markets responded positively to this news, as it provides some surety to what global trade and economics will look like over the next few years. All in all, the trade issues coupled with weak global currencies have continued to drag on international markets, pushing them into negative territory for the year.
Other investable assets like bonds and commodities moved opposite directions in September, following the basic premise of diversification. Bond prices fell, due to higher interest rates decreasing the attractiveness of their fixed rate interest payments. Why buy an old bond paying me 2 percent when I can buy a new one paying me 3 percent? Despite the drop in prices, the preferred bond index known as the Bloomberg Barclays Aggregate Bond Index only fell by 2/3rds of a percent, as the safety of bonds doesn’t often lead to significant losses. Commodity prices surged higher, mainly due to the recent rise in oil prices. We can all thank President Trump and Mr. Putin for this one, as the U.S. has effectively implemented economic sanctions on Iran and Russia jointly agreed with OPEC to curb oil supply. This leads to less and less barrels coming to market, which increases prices due to basic supply and demand dynamics. Overall, investments in bonds and commodities produced mixed results for investors in September but continue to serve as diversification tool and an alternative source of growth, an important function given the current volatility of the equity markets.