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The Gloves Are Off


  • Markets enter the historically volatile fourth quarter with high expectations that global growth and corporate earnings can rebound.

  • Mounting geopolitical stresses—China-U.S. Trade War, Fed independence, protests in Hong Kong, Brexit and the Aramco Attacks—have all generally been dismissed by markets.

  • It appears central banks can continue to commit to easy monetary policies even if inflation metrics move higher than stated targets.


Asset prices were mixed in the third quarter as stocks saw-toothed sideways but made little forward progress. Without significant gains or losses, the quarter seemed relatively benign on the surface; however, the flurry (or fury) of tweets from the President of the United States regarding trade with China pushed markets around like Muhammed Ali in the boxing ring. The ever-escalating trade tensions dominated the headlines. Each round involved more telephone calls, meetings, cancelled trips and dozens of tweets – yet no real progress. By December, there will likely be a 21% tariff on over $300 billion in goods that China produces and the U.S. buys. Additionally, by year end, nearly 99% of all imports from China may have tariffs. This compares to roughly 69% in September.

It is especially concerning that trade tensions are increasing while the global economy is showing material signs of weakness.


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Source: Bloomberg.

The global JPMorgan-Markit Manufacturing Purchasing Manager Indices (PMI) continued to signal outright contraction in September, and developed economies, such as Japan and Germany, were at or below their second-quarter levels. Emerging markets rebounded slightly due to a minor bounce in China.

The bout between the two largest economies in the world is starting to affect U.S. businesses. The September’s Institute for Supply Management (ISM) which measures U.S. manufacturing fell below 50.0, to 47.8 which signals an overall contraction. The much larger services sector slowed significantly falling to 52.6, according in the ISM Non-manufacturing index. Additionally, the Business Roundtable CEO Economic Outlook Index sank in September to the lowest level of the Trump presidency. The one-two punch of “potential trade war” and “slowing global economic growth” was clearly a factor.

Not all the news was terrible. In a recent Fortune interview, Blackstone CEO Steve Schwarzman summarized some of the lingering positives that have so far helped stave off recession:

Consumer buying is going up…If [consumers] continue spending that money, we’ll have a longer run.

Comments from Home Depot executive vice president of merchandising, Ted Decker, speaks to the collateral damage, but also potential opportunity:

I’m not aware of a single supplier who is not moving some form of manufacturing outside China. So, we have suppliers moving production to Taiwan, to Vietnam, to Thailand, Indonesia and even back into the United States.

An epic decline in global yields occurred as central banks around the world continued to ease their monetary policy to counter deteriorating fundamentals. The 10-year U.S. Treasury yield started the quarter at 2.0%, moved below 1.5% before ending the quarter at 1.68%. The two-year note had a similar movement from 1.75% to 1.47% ending the quarter at 1.63%. All maturities that make the yield curve declined during the quarter while some segments (2-year, 10 year) rates inverted for a few days at the end of August. Total negative-yielding debt hit $16 trillion globally by the end of the quarter—a staggering $3 trillion increase. In what seems to be a logical response to lower interest rates and additional quantitative easing, gold was the best performing asset for the quarter, up 5.4%. It has so far risen 16.1% during 2019.

The silver lining of the trade war may be that it has given the Federal Open Market Committee (FOMC) cover to end quantitative tightening early and lower interest rates at its past two meetings. As Chairman Jerome Powell said in his prepared remarks at the FOMC September press conference:

As I mentioned, weakness in global growth and trade policy uncertainty have weighed on the economy and pose ongoing risks. These factors, in conjunction with muted inflation pressures, have led us to shift our views about appropriate monetary policy over time toward a lower path for the federal funds rate, and this shift has supported the outlook.   

The Fed’s easing comes when the unemployment rate is at its lowest level, 3.5%, since the late 1960s. The Consumer Price Index (CPI) sits at 1.8%, and the U.S. stock market is within a few percent of all-time highs. The FOMC risks a significant divergence between asset prices and economic fundamentals with the current course of monetary policy.

Despite the Fed’s maneuvers, the president wanted more. Indeed, more may be needed to arrest a slowing economy in time for the election next year. Nothing captured the president’s frustration with the Fed more than an August 23rd tweet where Mr. Trump channeled his inner Ali—perhaps the greatest trash-talker of all time.

….My only question is, who is our bigger enemy, Jay Powell or Chairman XI?



U.S. equities were mixed during the third quarter. Large cap stocks generated positive returns of 1.4%, while small cap stocks were down -2.4%. However, Large caps have posted solid returns of 20.5% YTD while small caps remain strong at 14.2%.

Lower interest rates significantly influenced sector-level performance; those most sensitive to rates performed the best. For the quarter, utilities returned 9.3%, real estate was up 7.7%, and consumer staples increased 6.1%. Materials, health care, and energy all posted negative returns for the quarter. Eight sectors in the S&P 500 have generated more than 20% on a year-to-date basis. Health care and energy have been the significant trailers for the year, generating returns of 6% or less.

Amid the precipitous drop in interest rates, most fixed income asset classes produced attractive quarterly returns. The U.S. Aggregate Bond Index was up 2.3% in the quarter and is now up 8.5% for the year. High Yield Corporate bonds increased by 1.3% during the third quarter and are up 11.4% for the year.  Hinting at growing stresses, the lower quality part of the market (CCC) is only up 6% for the year and is the only segment of the high yield market that has posted negative returns (-4%) over the past 12 months. Markets clearly expect low rates to persist: dedicated bank loan mutual funds have experienced more than 40 consecutive weeks of outflows. 

Municipal bonds gained 0.8%, leaving them up 4.7% so far in 2019. Emerging market bonds were up 1.5% in the quarter, pushing that sector to a 13.0% return in 2019. International developed market bonds, which are saddled with negative yielding interest rates, declined by .70%, leaving the asset class up 4.5% for the year


The majority of international countries, both developed and emerging, posted negative returns in the third quarter. Hong Kong was down nearly 12% as four months of protests, known as the Anti-Extradition Law Amendment Bill Movement, continued into the fourth quarter. Germany, lower by 4.0%, remains mired in a manufacturing slump that has showed no signs of receding. The UK still has not resolved Brexit, and newly elected Prime Minister Boris Johnson has been adamant that the October 31 deadline will not be moved. The UK equity market was down 2.5% in the quarter. Japan was the notable positive performer, gaining 3.1% in the quarter.

In emerging markets, all but Turkey were negative in the quarter. China was down 4.7%, bringing its year-to-date return to just under 8%. China’s GDP growth was just 6.2% last quarter, the slowest on record since 1992. In eastern Saudi Arabia, Aramco’s oil processing plants came under attack one evening in September. This sent oil prices skyrocketing to the mid-$60s per barrel of oil. As fears eased about how long production would be offline, oil settled back into the $50s by the end of the quarter.

Developed international, as measured by the MSCI EAFE Index, declined 1.0%, leaving it higher by 13.3% so far this year. The MSCI Emerging Markets Index was lower by 4.1% and is now up 6.1% in 2019.


Current market expectations suggest that economic data and earnings may be picking up momentum for the remainder of the year and into 2020. Much of this potential strength will fall on the U.S. consumer, who enters this part of the economic cycle with a personal savings rate of 8.1%—a high not experienced much during this economic expansion. It is unclear at this point whether the consumer is pulling back spending in a structural or cyclical way. We will reserve judgement at this time as there are numerous factors to consider, with the main event being the 2020 U.S. presidential election.


Our focus is to allocate capital into areas of the market that are attractively valued or represent an inefficiency that can be exploited. We remain just as focused on the risk-side of the equation and seek to deemphasize or avoid overvalued and overcapitalized areas of the market. In some instances, the risks present the opportunity for reward, and we will bring those to your attention as we uncover them.

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