Room to Run
- July 11, 2019
Why we remain optimistic that the current economic and market expansion still has legs.
Signs of trouble abound. Trade tensions persist between the United States and China despite the recent truce reached at the G20 Summit. Global economic growth is slowing with trade tensions having a lot to do with it. Corporate earnings growth had slowed significantly in the second quarter. Geopolitical tensions are rising in the Middle East. The Treasury yield curve has been inverted. One thing to remember is that there are always concerning events taking place in the world. The key is looking through the noise and focusing on what’s important. In our view, the topics to focus on are inflation, economic growth, valuations and the yield curve.
Topics
Headline CPI is hovering around 2% and is trending at its highest level in three years. The PCE deflator, the inflation gauge watched closely by the Fed, is running at about 1.5%. Overall, inflation has been stubbornly low despite the Federal Reserve’s efforts to increase it. With unemployment at historically low levels, the Fed has been expecting a more meaningful increase in wage inflation, which could feed into headline inflation and, ultimately, economic growth.
We’re currently in the longest economic expansion in U.S. history at 119 months. First-quarter real GDP came in at 3.1%. The expectation is for GDP growth to slow. Recent economic data has been mixed. Trade tensions are beginning to have an impact, especially in manufacturing and other segments of the economy that are heavily export-dependent. As long as trade tensions persist, we could see continued deterioration in economic data and slowing GDP growth as companies cut capital expenditures.
U.S equity valuations are trading near long-term averages. As of May 31, the S&P 500 has a forward P/E multiple of 15.7, which is below the S&P 500 25-year average of 16.2. Equity valuations will continue to be measured relative to interest rates, which remain historically low and could potentially move lower. Lower rates would bolster the case for higher equity valuations. As always, some segments of the market are more expensive than others. Currently, defensive sectors like real estate, utilities and consumer staples are the most expensive sectors while financials, industrials and health care are the least expensive. Richly valued defensive sectors suggest that investors are nervous and investing in bond surrogates (high-yielding equities with perceived downside protection.) However, we remain cautious about those segments given their above-market valuations.
The Treasury curve has been flat to inverted in 2019. The 30-year Treasury has declined to yield 2.58% and the 10-year Treasury declined to 2.14% as of May 31, 2019. Together, slowing growth expectations and rising demand for Treasuries from overseas investors have pushed yields on the long end lower. Roughly 29% of global government bonds have negative yields, making Treasuries attractive relative to other developed sovereign bonds. The short end of the yield curve is primarily driven by the Fed, which has put a halt to rate hikes. Meanwhile, the market has begun to price in rate cuts for this year due to recessionary fears. We agree that with low inflation and slowing economic growth expectations there is a higher chance of a rate cut than a rate hike. Regardless, we believe that the Fed will serve as a backstop, looking to help prevent an economic recession and support the markets.
Our Views
Overall, while the risk of recession has increased recently, we believe that the economic expansion will continue for the foreseeable future. The market, on the other hand, is a forward-looking mechanism that will be volatile as long as uncertainty regarding the Fed, trade and the extent of the slowdown in global growth continues. Our overall asset class views have only changed modestly since the beginning of the year when we published our 2019 outlook. We firmly believe that inflation is at bay, fundamentals remain intact and economic growth continues, albeit at a slower rate.
Given these factors, we feel that recession risk is not a current concern, but it is something to monitor as some recession indicators are beginning to flash red. We remain committed to current positioning and continue to emphasize portfolio diversification. At the same time, now could be an ideal opportunity to allocate excess cash and realized gains from overvalued investments to segments of the market we find most attractive.
If you have questions or need more information on our investment capabilities, please contact an Oppenheimer Financial Advisor.
Disclosures
The opinions expressed herein are subject to change without notice. The information and statistical data contained herein has been obtained from sources we believe to be reliable. Past performance is not a guarantee of future results. The above discussion is for illustrative purposes only and mention of any security should not be construed as a recommendation to buy or sell and may not represent all investment managers or mutual funds bought, sold, or recommended for client’s accounts. There is no guarantee that the above-mentioned investments will be held for a client’s account, nor should it be assumed that they were or will be profitable. The Consulting Group is a division of Oppenheimer Asset Management Inc. (OAM). OAM is an indirect, wholly owned subsidiary of Oppenheimer Holdings Inc., which also indirectly wholly owns Oppenheimer & Co. Inc. (Oppenheimer), a registered broker dealer and investment adviser. Securities are offered through Oppenheimer.
For information about the advisory programs available through OAM and Oppenheimer, please contact your Oppenheimer financial advisor for a copy of each firm’s ADV Part 2A. Adopting a fee-based account program may not be suitable for all investors; anticipated annual commission costs should be compared to anticipated annual fees.
S&P 500 Index measures performance of U.S. large-cap companies.
MSCI AC World ex-USA Index captures large- and mid- cap representation across 22 of 23 developed-market countries (excluding the US) and 24 emerging-market countries.
LTM PE Ratio is the last 12-month price-to-earnings ratio.
Indices are unmanaged, do not reflect the costs associated with buying and selling securities and are not available for direct investment.
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Special Risks of Fixed Income Securities - For fixed income securities, there is a risk that the price of these securities will go down as interest rates rise. Another risk of fixed income securities is credit risk, which is the risk that an issuer of a bond will not be able to make principal and interest payments on time.
Liquidity Risk. Liquidity risk is the risk that you might not be able to buy or sell investments quickly for a price that is close to the true underlying value of the asset. When a bond is said to be liquid, there's generally an active market of investors buying and selling that type of bond.
Market risk: Fixed income securities markets are subject to many factors, including economic conditions, government regulations, market sentiment, and local and international political events. Further, the market value of fixed-income securities will fluctuate depending on changes in interest rates, currency values and the creditworthiness of the issuer.
Special Risks of Master Limited Partnerships: Master limited partnerships are publicly listed securities that trade much like a stock, but they are taxed as partnerships. MLPs are typically concentrated investments in assets such as oil, timber, gold and real estate. The risks of MLPs include concentration risk, illiquidity, exposure to potential volatility, tax reporting complexity, fiscal policy and market risk. MLPs are not suitable for all investors. 2624906.1