As we finally begin to enjoy some warmer days and early spring weather, we find ourselves relieved that the fall and winter months are behind us. Many of the market pundits spent lots of time in the fall describing how bad things were and after the New Year, how good things were. The S&P 500 closed the 3rd quarter at 2913.98. By December 24th the S&P 500 had dropped to 2351.10. By the end of the 1st quarter this year, the market was just about back to where it was at the end of September with a close of 2,834.40. In the short run, news and emotions can drive markets. This is a lot of what we saw the last 6 months. In the long run, economic growth and profits drive markets. Within the context of economic growth and profits, investors often allocate investment capital to those markets that they believe have the best growth potential. We believe that non-US based investors have been and will continue to allocate more capital to the US market for at least the rest of this year.
Let’s look at just one scenario where this has played out over the last six months.
- October 2018: China Slows Down – In the midst of growing and unresolved tensions with the US, China announced that it had its lowest level of growth in over a decade as their domestic consumption and industrial output slowed. The Chinese government implemented various measures meant to stimulate the economy.(1)
- January 2019: European Union Exports Slump – As the Chinese economy continued to slow, it began to affect the European Union, which is one of China’s largest trading partners. From October to January alone, EU exports dropped by more than 13%.(2)
- March 2019: European leaders try to encourage growth – In light of the slowdown in exports and the overall economy, the European Central Bank (ECB) announced that they will keep interest rates low for the foreseeable future. The ECB hopes that keeping interest rates low will lead people and companies to spur the economy out of its slump because they can continue to borrow for the foreseeable future at very low interest rates.
- Money Flows into the US – Despite the Chinese and ECB efforts, many investors have reached three conclusions that are driving foreign investments into the US:
- With interest rates in Europe and across the globe staying flat or decreasing, investors allocate “safe money” to US treasury bills and bonds. Earning over 2% on US treasury bills versus almost 0% in Europe makes sense as long as the value of the dollar versus the Euro does not decrease.
- The relative growth rate of the US economy is greater than Europe and while China’s growth rate is higher than the US, the risks related to the bubbling US trade war make the US economy a relatively better choice
- That because investments are flowing into the US the demand for dollars is likely stay high and therefore it is likely that the value of the dollar relative to other currencies is likely to stay stable or increase.
A couple of additional considerations:
- Emerging Markets: In our last newsletter we noted that the US market had been outperforming the international markets in part because investors were unnerved by the fact that emerging markets had a significant amount of dollar-denominated debt that they would need to pay back in 2019. As we entered the new year, however, investors seemed to forget these concerns as they became more optimistic on the possibility of a US-China trade deal, driving emerging market values up. One indication of this was the iShares MSCI Emerging Market Index (ticker: EEM) rose more than 13%. Our view is that although it has been nice to see the international markets rise, we still do not believe the emerging markets’ troubles are behind them. The large capital inflows into the US discussed above should lead to a stronger dollar which is a negative for emerging markets because a strong US dollar means it is harder for Emerging Market Governments and Corporations to pay back their debt which is primarily denominated in dollars. Adding to their difficulties is the fact that there is still the risk of prolonged tensions between the US and China, and continued uncertainty surrounding countries like Venezuela and Iran. Consequently, we are not currently overweighting emerging markets in our investment portfolios.
- The Exception – India: One emerging market that we do feel cautiously optimistic about, however, is India. Cautious because the country still needs to enact several political reforms to decrease the government’s bureaucracy, but optimistic, since over 50% of the population is under the age of 25 and the country has been rapidly increasing its infrastructure.(4) Essentially, we believe India looks to be attractive over the long-term as it can achieve the same rapid growth that China saw in the early 2000s.
- Interest Rates: On March 20, 2019, Federal Reserve Chairman Jerome Powell announced that he would not be increasing interest rates but instead hold them at their current rates for “some time” as the Fed continues to weigh economic conditions.(3) This announcement not only caught investors by surprise since most individuals expected the Fed to continue raising rates, but it also led us to re-evaluate our investment outlook:
- Financials vs Utilities & Real Estate: With interest rates looking to stay steady, or even decrease over the next two years, we believe investors should not overweight their exposure to banks; a sector we have previously been positive on. When interest rates stop rising, banks are not able to continue growing their profits by earning more revenue on the money they have sitting in checking / savings accounts. As a result, we would shift our financial exposure away from bank stocks and more toward companies that are less interest rate-sensitive. For example, we believe that investors should ensure they are not underweight exposure to real estate or utilities, two sectors that have been largely ignored by many investors during the recent market growth. Both of these sectors use a significant amount of debt to run their operations. As a result, when interest rates stop rising, the cost of paying interest on this debt also stops rising, making the companies more profitable.
A Final Note
Overall, we still believe that 2019 will be a positive year of growth for the stock market given that key data points such as profit growth, unemployment and inflation all still look good and investors are not showing any high level of unexplained exuberance, which usually precedes a stock market recession. That being said, we are now in our ninth straight year of the bull market and although company earnings are generally growing, they are not growing as quickly as a year ago. As a result, we believe this is an optimal time for each investor to review their investment portfolio allocations, including potentially making some of the adjustments discussed in this commentary.
As always, if you have any questions, please do not hesitate to reach out.
Wishing you a wonderful Spring season,
The Glen Eagle Investment Team
1. https://www.bloomberg.com/news/articles/2018-10-19/china-economic-growth-slows-more-than-expected-in-third-quarter 2. https://tradingeconomics.com/european-union/exports 3. https://www.bloomberg.com/news/articles/2019-03-20/fed-sees-no-2019-hikes-plans-september-end-to-asset-drawdown 4. http://censusindia.gov.in/Census_And_You/age_structure_and_marital_status.aspx
Disclosure: This commentary is furnished for the use of Glen Eagle Advisors, LLC, Glen Eagle Wealth, LLC and their clients. It does not constitute the provision of investment advice to any person. It is not prepared with respect to the specific objectives, financial situation or particular needs of any specific person. Investors reading this commentary should consult with their Glen Eagle representative regarding the appropriateness of investing in any securities or adapting any investment strategies discussed or recommended in this commentary.