Dear Clients & Friends,
It’s time for our monthly market risk update written by our good friend Brad McMillan. I also want to give a shout-out to our colleague Sam Millette for helping with this month’s article. As we did last month, we are going to look more at economic factors than market metrics; both are equally important.
The summary is this: the outlook is getting grim, but we do not think that the economy, or the market, will turn over in the very near future. However, we are slowly but surely working to reduce risk in all client portfolios because we are worried about 2020 and 2021. I cannot say for sure, but I expect that we will want to reduce risk again in early 2020. These predictions are in line with a forecast we made in February 2018 for a possible recession in 2020. In the meantime, bolstered by positive feedback from our family of clientele, we are very pleased with our 2019 performance (especially given our reduced risk exposure). That being said - Brad, take it away…
Overall, the economic data released last month came in worse than expected. There was a sharp decline in two of our metrics, consumer confidence and service sector business confidence. Job creation was more mixed, as the pace of new job growth remains below that of 2018 but is still at a level above the trouble zone on a year-to-year basis. The yield curve remains inverted, which also keeps that risk metric alive. Although we are not yet at immediate risk levels, conditions continue to deteriorate, and the risks have risen.
The Service Sector
Signal: Yellow light
This survey of confidence for the service sector of the economy fell sharply last month, as a slowdown in current activity and new orders spooked businesses. This result was the largest year-over-year drop in confidence we’ve seen since 2009, and it brings us to a three-year low for the index. This is a diffusion index, where values above 50 indicate expansion. So, we are not yet in a service sector recession, but the clear downward trend in confidence this year is concerning. For now, we’ll keep this indicator at a yellow light.
Private Employment: Annual Change
Signal: Green light (shade of yellow)
September was a mixed month for new jobs, as only 95,000 were added against expectations for 145,000. But the underlying data was a bit better: the underemployment and unemployment rates both fell, with unemployment hitting a 50-year low of 3.5 percent. Despite the low unemployment rate, wage growth disappointed during the month by remaining flat. We are not currently at risk levels, but the slowdown in year-over-year growth is worth monitoring. For now, we’ll keep this indicator as a green light, although the ongoing slowdown in job growth is taking us closer to yellow light status.
Private Employment: Monthly Change
Signal: Yellow light
These are the same numbers as in the previous chart but on a month-to-month basis, which can provide a better short-term signal.Month-over-month job growth was positive again in September; however, we still sit well below levels seen in 2018. This slowdown in monthly job creation, combined with the slowing year-over-year growth rate, indicates that the overall pace of job growth is slowing. Due to this slowdown, this indicator remains at a yellow light.
Yield Curve (10-Year Minus 3-Month Treasury Rates)
Signal: Yellow light (trending to red)
The yield curve remained inverted in September, despite an increase in long-term rates during the month. The 10-year Treasury yield rose from 1.47 percent to start the month to 1.68 percent at month-end. Yields on the short end of the curve fell during the month, as the Fed cut the federal funds rate at its September meeting by 25 bps, as expected. The yield on the 3-month Treasury fell from 1.98 percent at the start of the month to 1.88 percent by month-end. Market participants widely expect the Fed to cut the federal funds rate by another 25 bps at its December meeting.
As the length of the inversion grows, it is getting close to starting a recession countdown. But it is not quite there yet. Given that and the delay between such an inversion and the actual start of a recession, the immediate risk remains low. As such, along with other signs of weakness, the indicator remains something to watch. We are keeping this measure at a yellow light this month, with a shade of red.
Consumer Confidence: Annual Change
Signal: Yellow light (trending to red)
Consumer confidence fell during the month, from 135.1 in August to 125.1 in September, against expectations for a more modest decline to 133. This represents a 7.5-point decline on a year-over-year basis, which is getting close to the 20-point decline that historically has signaled a recession. Although confidence still sits at high levels on an absolute basis, this year-over-year decline is discouraging, as rising confidence can help support faster consumer spending. The slowdown in job creation and sluggish wage growth this year likely contributed to this drop in consumer confidence. This indicator remains a yellow light for now, but the sudden drop over the past two months has added a shade of red.
Conclusion: Risk remains elevated
All things considered, September saw risks increasing across all of our core metrics. The sudden decline in consumer confidence is especially worrying, as consumer spending has been one of the major drivers of growth for much of this year.
Although a continued slowdown remains the most likely case based on the data, a slowdown is not a recession—we likely still have a couple of quarters to go there. Nonetheless, the bulk of the data indicates the risks of a worsening slowdown remain material (again, not yet as the base case). As such, we are leaving the overall risk level at a yellow light for the economy as a whole for October.
Brad and Sam’s notes are a little scary, but we don’t see the economy crashing into a brick wall within the next 2 months. In fact, we think there is good reason to believe that the trade war with China will be resolved before September of 2020. This will likely cause an upward spike in the market regardless of economic conditions.
So, we are weighing many factors. The most important points are that we are well positioned for an economic slowdown, and that performance this year has been very pleasing despite reduced risk in client portfolios.
Have a lovely weekend,
Matthew Ramer, AIF® Principal, Financial Advisor MOR Wealth Management, LLC
1801 Market Street, Suite 2435 Philadelphia, PA 19103 P: 267.930-8301 | c: 215-694-4784 | f: 267.284.4847 |
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The majority of this content was written and distributed MOR Wealth Management, all rights reserved. Securities and advisory services offered through Commonwealth Financial Network, Member FINRA/SIPC, a registered investment adviser. Fixed insurance products and services offered through CES Insurance Agency.
Securities and advisory services offered through Commonwealth Financial Network, Member FINRA/SIPC, a registered investment adviser. Fixed insurance products and services offered through CES Insurance Agency. Certain sections of this commentary contain forward-looking statements that are based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. As stated above, commentary for the 5 risk factors provided by Brad McMillan and published in the Independent Market Observer. Past performance is not indicative of future results. Diversification does not assure a profit or protect against loss in declining markets. The S and P 500 Index is a broad-based measurement of changes in stock market conditions based on the average performance of 500 widely held common stocks. All indices are unmanaged and investors cannot invest directly into an index. The MSCI EAFE Index (Europe, Australasia, Far East) 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. The MSCI EAFE Index consists of 21 developed market country indices.