ECONOMIC FLASH Better-than-Expected but Not-So-Great Economy

November 1st, 2019

We remain marginally biased toward risk reduction and recommend topping up exposures to core fixed-income and other more defensive sectors, such as infrastructure equities. At this time, we don’t recommend investors make dramatic shifts as there remains upside in our view.

US Economy: Tepid growth beats expectations.

The third quarter of 2019 GDP in the United States increased at an annualized rate of 1.9 percent, which was somewhat lower than the second quarter result (2.0 percent) but higher than analyst expectations. While consumer spending in the United States is reasonably strong (+2.9 percent in the third quarter) and the labor market remains solid, business investment continues to fall (-1.5 percent in the third quarter) in the face of prolonged trade uncertainties.

US Stocks: Lower profits beat estimates.

The 40% of S&P 500 companies reporting so far for 3rd quarter 2019 showed a drop in earnings of nearly 4% vs. the year-earlier period. However, these results beat analyst estimates and corporate revenue has been growing. Small caps have more recently begun to outperform since their earnings are generally less affected by the strong US dollar.

Foreign Stocks: Trade news boost EM.

Foreign equities outperformed US stocks with strong results in the emerging markets (EM). Emerging market stocks have been stuck in a bit of limbo as the trade war ebbs and flows but a partial agreement between the US and China, as well as central bank stimulus, have helped them break out.

Fixed Income: How low will the Fed go?

As US economic data has worsened, the Fed dropped its target interest rate for the third time in 2019 to the 1.5 percent - 1.75 percent range. Nonetheless, Fed Chair Jerome Powell clearly signaled that this latest cut would likely be the last for the foreseeable future, noting that previous cuts had begun to have a positive impact.

Real Assets: Gold, commodities rally.

In October, commodities lead the real assets category. While poor global growth and rising stockpiles hampered oil prices, gold and other precious metals did strongly as perceived safe havens and bets on accommodating monetary policy.

Alternatives: Hedge funds in the black.

In general, hedge funds performed well in October. Equity hedge and event-driven strategies benefited from rising equity markets, while unpredictable interest rate markets hampered systematic macro techniques.

Our Take

The prevailing mood among investors appears to be pessimistic, and with good reason: Much of the forward-looking US economic data has softened (if not contracted), and the Fed has, in a 180-degree turn from a year ago, cut interest rates three times in a four-month period to boost the economy. While we agree that it is prudent to make hay while the sun shines (we have been taking steps to decrease risk in our portfolios throughout 2019), it appears plausible that market concerns are overblown and overstate the most likely downside when the long-running US boom ultimately comes to a halt.

For starters, the United States appears to be far healthier and better positioned than most of its trading partners. Furthermore, US consumers continue to be the primary driver of the US economy, and household job prospects and finances remain robust. Finally, neither equities nor fixed income are overvalued in the financial markets. Prior to the last recession (2008-2009), none of these characteristics were good, and the consequences were severe. Even though the sharp drops of a decade ago continue to haunt investors, it appears that an economic standstill or slowdown is now a much more plausible result.

In terms of portfolio positioning, we remain modestly risk-averse and propose increasing exposure to core fixed-income and other more protective sectors, such as infrastructure equities. However, the excellent year-to-date results have largely countered the poor performance of previous year, leaving portfolios at sensible valuations rather than high peaks. We don't propose big changes at this time since we feel there is still room for upside, and we believe our portfolios are well-positioned should a downturn occur.

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