In August, the U.S. stock market was crowned the longest-running bull market in history (by some measures) as it marked its 3,453rd day. While some investors toasted the rally’s impressive length, many began asking, “Should I be getting out of this market?”
As investors contemplate the meaning of the new record—and the subsequent early-October pullback—a few key contextual points are important to consider. First, the bull market record has been set amid a relatively small sample size: There have been only a handful of bull markets in modern U.S. financial history. Furthermore, it is important to consider the length of the bull market within the context of a long-term investment horizon. If you’re investing with a 15- or 30-year horizon, a 3,453-day old bull market doesn’t necessarily mean you should change your investment strategy. And lastly, every bull market is different, driven and affected by varying factors.
At SigFig, we believe that there are more important reasons to assess the investment landscape than a somewhat arbitrary bull market milestone. In our view, economic strength and macroeconomic conditions, corporate earnings, trade wars, deregulatory trends, tax policy, and contagion in emerging markets are some factors worth assessing — and these are the topics we cover in our third-quarter market update. As it turns out, these were among the factors which have made October one of the most volatile months for stocks this year: Ongoing trade worries, geopolitical tensions, and rising interest rates have been counted as key drivers of the sharp declines posted in the early fourth quarter. Here we’ll summarize major developments in these areas during the third quarter, laying the foundation for a better understanding of the forces that are likely to continue impacting markets in the fourth quarter.
Trade war tit-for-tat escalates
The trade war between the U.S. and China certainly did not cool during the third quarter. President Trump announced tariffs on an additional $200 billion worth of Chinese goods, many of them consumer products. The tariffs went into effect on September 24th at 10% and are scheduled to climb to 25% on January 1st. China promptly retaliated by announcing tariffs on $60 billion of U.S. products, including farm goods, machinery and chemicals, with levies ranging from 5% to 10%. In response, President Trump threatened he would consider slapping tariffs on virtually all Chinese goods imported to the U.S. if Beijing were to take action against U.S. farmers and workers.
The consequences are mounting. The Federal Reserve reported tariffs contribute to rising input costs, mainly for manufacturers, and noted that uncertainty about trade tensions is prompting some businesses to scale back or postpone capital investment. Additionally, The Wall Street Journal reported California farmers are struggling with heavy retaliatory tariffs imposed by China as well as other big export markets, including the European Union, Canada and Mexico. As a last example, Chinese tech mogul Jack Ma, executive chairman of e-commerce giant Alibaba, has walked back his pledge to create one million jobs in the U.S., blaming trade tensions.
Despite President Trump’s “America first” policies, the U.S. trade deficit expanded for the second consecutive month in July. The latest data showed the deficit at $50.1 billion, a five-month high. In particular, the deficit with China grew to $36.8 billion, a record high.
U.S. economy remains on its strongest footing in years
U.S. stocks advanced in the third quarter as economic and corporate fundamentals remained largely healthy. GDP growth for the second quarter was revised upward to a 4.2% annual rate from an initial estimate of 4.1%, powered by strong consumer and government spending and firm business investment. Hiring also heated up in August as U.S. non-farm payrolls expanded by 201,000, marking the record 95th consecutive month of job growth. And at long last, wages showed upward momentum: Average hourly earnings grew 2.9% year-over-year, the best rate since 2009. Consumer confidence also increased in August, reaching its highest level since October 2000. Such historically high confidence levels are expected to continue to support strong near-term consumer spending.
Corporate earnings remain robust, as 80% of the companies in the S&P 500 Index reported second-quarter earnings per share (EPS) that beat estimates. Even more impressively, these EPS estimates were not lowered coming into the earnings season: Analyst expectations had actually increased in anticipation of good news, and companies were still able to beat them. In all, U.S. stocks advanced, with the Vanguard Total Stock Market ETF (VTI) gaining 7.1% during the quarter.
As the economy looked strong by most measures, the Federal Reserve raised its benchmark interest rate at its September meeting, as widely expected. The Federal Open Market Committee voted to lift the target range for the federal funds rate by 25 basis points (a quarter of one percent) to between 2% and 2.25% and continued to project one more hike before year-end and three in 2019.
Looking ahead: Keeping an eye on deregulatory trends
As the U.S. midterm elections draw closer, polls indicate that Republicans are poised to lose their majority in the House of Representatives. In the Senate, Republicans are likely to retain their slim majority but are expected to face competitive races for several seats. As such, it seems unlikely that much legislation will move forward between 2019 and 2020. Continued deregulatory efforts are now more likely to come from more conservative-leaning courts or through Presidential executive orders.
Eurozone economic growth stalls while Japan bounces back
Overseas, stocks in developed international markets generally posted small gains in the third quarter, with the Vanguard FTSE Developed Markets ETF (VEA) gaining1.3%.
Economic growth accelerated in the U.K. in July, though the country continues to battle concerns over Britain’s withdrawal from the European Union. In late September, E.U. leaders firmly rejected Prime Minister Theresa May’s proposal for how to maintain economic relations with the E.U. post-Brexit, intensifying the pressure as Britain plans to leave the bloc on March 29, 2019. Meanwhile, companies such as Panasonic, MUFG and Nomura Holdings have decided to move their European headquarters out of London amid uncertainty surrounding Brexit.
In Japan, the economy returned to solid growth in the second quarter, expanding at an annualized pace of 1.9%, bolstered by improvements in private consumption. This follows a 0.9% contraction in the first quarter, which ended a long stretch of growth. As inflation remains well below the Bank of Japan’s 2% target, the central bank has largely maintained its massive monetary stimulus.
Emerging markets feel ongoing strains
Stocks in emerging markets faced continued headwinds in the third quarter as concerns about contagion were driven by worries about higher debt burdens, slower growth and a less favorable trade environment. In all, the Vanguard FTSE Emerging Markets ETF (VWO) declined 1.6%.
As we described last quarter, multiple emerging equity, bond and currency markets have been struggling so far this year, partially due to a strong U.S. dollar, which is helped by a positive outlook for the U.S. economy and broad expectations that the Fed will continue to hike rates this year. Higher rates and a stronger U.S. dollar are re-balancing the risk-reward equation worldwide, acting as a magnet to pull some investors out of riskier investments in developing economies. Plus, many emerging countries have large debts based in U.S. dollars — so repayment becomes more difficult as the dollar strengthens. Earlier this year, based on our observations, SigFig made some adjustments to client portfolios as a result of these debt issues. Although we cannot predict how this current stress will pan out in the near-term, SigFig continues to endorse the long-term advantages of diversifying across multiple asset classes.
Focusing on the most critical investment decision
At SigFig, our advice remains consistent, regardless of new bull market records or short-term sell-offs. In our view, the most critical decision investors can make is about their investment horizon: Once this is known, the rest can be optimized. We maintain our view that clients are well served by investing in a strategic, globally diversified portfolio that is aligned with their preferred risk tolerance and time horizon.
Aaron Gubin leads research for SigFig’s Wealth Management team. He holds a Ph.D. in Finance and taught investments and portfolio management to graduate and undergraduate students before coming to SigFig. His research focuses on asset allocation, behavioral finance, and investment management.