Market Outlook, Post-Elections

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Written by J. Cannon Carr, Jr. on November 14, 2018

With the mid-term elections behind us[1], we believe three issues will continue to dominate markets for the near-term:

  • The intensity of trade wars between the US and China
  • Plans by the Fed to raise interest rates
  • Whether there is “too much stimulus” at a time when the US economy is hitting on all cylinders

Overall, the US economy seems to be doing very well. Corporate earnings are strong, unemployment is at historic lows, and wage growth is finally picking up. But the market has concerns this will change, as we saw in October, when the S&P 500 was down almost 9% at one point and yields were rising. The concern is that too much stimulus in a strong economy could lead to unintended consequences (higher budget deficits, inflation), and that rising rates combined with an adverse trade war with China could offset that stimulus and threaten recession.

We expect this tug-of-war between good economic data and macro fears of recession to continue, but we should point out that fears of recession are already apparent (to some extent) in several sectors and markets. Consider:

  • In the US, stocks of many industrial equipment manufacturers and home builders are down 15%-20% this year; likewise, stocks in energy are down on concerns about an oversupply of oil, and commodities-based producers are down relatively hard as well.
  • Outside the US, Emerging Markets are down over 10% (especially China, down about 20%) on a stronger US Dollar or concern over trade wars slowing global growth.
  • In fixed income, the yield curve has been flattening, although it is not signaling recession yet.

From a bottom-up perspective, our research finds that:

  • Growth stocks are at an extreme in performance. Value stocks are better positioned.
    • Incidentally, we are overweight cyclical stocks (e.g., capital goods manufacturers). They are now very cheap and present long-term opportunity. If fears of recession recede, these stocks could lead; if not, they could remain weak until growth improves.
  • October showed different dynamics vs. the past year.
    • Growth became a detractor, and Momentum lost its dominance. Value showed positive spreads for a change.
  • Emerging Markets continue to show some of the best valuations (about 11X trailing P/E, with 3% dividend yields), but near-term probably remain weak as the US Dollar strengthens and concerns over global growth prevail. We believe Emerging Markets have some of the widest value spreads, although it may be early to be aggressive.
  • US Value stocks are very attractive, and if Value comes back into style, it could help Developed International Markets as well. We believe the US market remains the most attractive in the Developed world, followed perhaps by UK, Singapore, Australia, and Hong Kong. Much of continental Europe remains less attractive currently, given challenges to economic growth.

Predicting how trade wars, rates, and the after-effects of stimulus evolve is difficult and generally fruitless to do. Instead, we seek to recognize market extremes—to help better position investments for future growth—and to incorporate a mix of diversified investments, so that we can better navigate near- and medium-term uncertainties.

[1] Regarding the mid-term elections, we do not expect the results to have a lingering impact on the market. Voters spoke largely as expected, with Democrats taking the House and Republicans maintaining (actually strengthening) their control of the Senate. The split in Congress will likely mean a bit more gridlock but no major changes to current policies. Checks and balances generally lead to better predictability (in domestic politics, at least), an environment investors tend to prefer.

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