A Spooky October
A Spooky October?
There have been some interesting market developments that are notable in global equities, bonds, and currencies.
Year to date, global stocks measured by the MSCI World Index are positive 2% +/- at the time of writing; US stocks measured by the Russell 3000 are positive 9% +/-, while global stocks excluding the US are down 6% +/- for the year (unhedged.) Hedged to the US dollar, global stocks excluding the US are largely flat year-to-date.
Through the first half of the year, the S&P 500 performance was driven by just a handful of stocks. The index heavyweights attracted flows of investment dollars as the trend towards “passive investing” continued. Too, investor optimism for the popular technology and consumer discretionary stocks drove outperformance in various stocks. These developments were not necessarily unusual, but caution was warranted.
Investor flows of money has shifted into US assets as economic data has been positive. Employment numbers, GDP growth, corporate earnings, consumer confidence, and inflation data continue to please market participants and our central bank chairman Jerome Powell. The consumer confidence index hit an 18-year high, a level hit last in the year 2000. The University of Michigan’s consumer sentiment index has also trended higher, at levels last surveyed in the early 2000’s. Weekly jobless claims measured by the number of people filing for unemployment benefits fell to a 49-year low; unemployment is squarely under the academic “normal” rate of 5%, currently below 4%. This data comes from the government’s U-3 rate of unemployment which is widely followed.
Quantitative Tightening and Interest Rates
Interest rates have been a key theme for us. The Fed recently raised rates as widely expected to a range of 2-2.25%. Less reported in the mainstream financial media is their bond buying and selling program of their $4.2 trillion balance sheet. The plan is to eventually let $50 billion worth of combined mortgage-backed securities and Treasuries run off the balance sheet each month. That is a lot of supply coming onto the market; they have reduced the figure from almost $4.5 trillion to $4.2 trillion since 2017.
Corporate and individual tax cuts have been a boon for the market; however, the US government continues to increase spending, which means that they have less tax revenue coming in and are simultaneously spending more. Since the Treasury must issue debt to fund the government’s deficit, supply rises. We are in a quantitative-tightening environment. The Fed is slowly unloading their debt securities on the market and most market participants are expecting another three rate hikes from the central bank (one this year, two next year) to get to a “neutral” rate environment (upper target of 3%.) “Neutral” is the level where central bankers think short-term rates neither help or hurt the economy.
China and Japan, the largest foreign holders of treasuries, are also net-sellers. As of October 2018, the US has the highest-yielding government bonds relative to other developed nations. This could help stabilize bond prices as we “tighten” monetary policy. Ten-year treasuries are yielding about 3.2% and the 30-year at about 3.4%. The spread between the two yields has been about 14 to 18 basis points of late, which is nearly flat.
Volatility in individual securities differs from that of the broader market and popular “VIX” index. CBOE’s volatility index has largely trended down since the early 2018 selloff. Recent positive trade rhetoric between the NAFTA countries and continued tensions on trade with China hasn’t yet caused a breakout up or down in the volatility index or in US stocks. Volatility in individual stocks has continued to present buying and selling opportunities throughout the year even as stocks trade above their long-term average valuation multiples. 2017 was an outlier in terms of sharp market moves – the biggest drop percentage-wise was only about 3% from a peak-to-trough for the S&P 500 index – which is near-zero volatility to the downside. We anticipate a higher, more normal level of volatility moving forward.
Emerging markets, China, India, the US dollar
Emerging markets have fared poorly of late as the US dollar rose in relation to other major currencies for a variety of reasons. The Indian Rupee has hit an all-time low relative to the USD. Notably, Indian stocks outperformed emerging market peers year-to-date but have been selling off since the end of August. Chinese equities are in bear-market territory since their high in January of 2018, down 20% +/-, measured by the Shanghai Composite. 2017 was a year of “global synchronized growth” which led to a high percentage of asset classes performing well across the world. This year, we have a US stock market that’s performing well, while the second-largest global economy is in bear-market territory, primarily due to Chinese growth concerns, high leverage and debt reform, and tariffs imposed by the US. The Indian markets and Chinese markets diverged until the Sensex (an Indian index) started falling as previously mentioned, while the US market hits new highs. These are substantial divergences – The US, the largest economy, has stocks near record-highs while the second-largest economy, China, is in a bear-market measured by the popular 20% rule.
Mortgage rates, housing, and energy
Housing and energy costs are two big expenditures of the average budget; both are rising and by nature, inflationary. Current quoted interest rates for a 30-year mortgage are about 4.7% per bankrate.com. They were under 4% in 2017. The difference of 70 basis points (0.70%) on a $200,000 mortgage, which is around the median home price, is an increase of about $1400 in the first year, or about $117 per month in increased interest expense. Also, the company Zillow indicates that homes have increased in value 6.5% +/- year over year. Housing activity is considered an underlying driver of the economy, and it is getting more expensive.
Interestingly, the Saudi Arabian Energy Minister said in early October that they will pump 10.7 million barrels per day in October and marginally more than that in November. For context, Saudi Arabia’s highest ever output was 10.72 million bpd set in November 2016. Simultaneously, the world’s largest crude producer, the US, is hitting record output. Two of the world’s largest energy producers are near record output. Still, the price of domestic and international oil has risen, partly to do to the political uncertainty surrounding Iran, another major energy producer.
While it is important for us to make sense of the broader macro developments like the ones in this update, we must maintain focus on the fundamentals of our specific investments and an eye out for the next opportunity. The world and the markets perpetually evolve; there is always learning to be done.
"An investment in knowledge pays the best interest."
- Benjamin Franklin
Have a wonderful Autumn.
Northstar Investment Management
This is not investment advice and may contain forward-looking statements. Readers should do their own due-diligence and fact-check. Asset prices will have changed from the time of writing. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is no guarantee of future results.