Seemingly unfazed by the worsening trade tensions with China and the ongoing Fed-tightening cycle, U.S. equity markets continued their upward ascent in the third quarter, with the S&P 500® Index and Dow Jones Industrial Average producing gains in each of July, August and September. The S&P 500 ended the most recent three-month period up 7.71%, while the Dow and NASDAQ finished up 9.63% and 7.41%, respectively. Astoundingly, all three indices hit all-time highs during the quarter as the current bull market became the longest in history, passing the previous record set between November 1990 and March 2000.
International equities were mixed in the third quarter as the MSCI EAFE Index finished up 1.35% and the MSCI Emerging Markets Index closed down -1.09%. Within Emerging Markets, Turkey was a major headline-grabber during the quarter as the lira tumbled to all-time lows. This, combined with increasing U.S. interest rates, a strong U.S. dollar and continued challenges in South Africa and Argentina, gave investors heartburn during the quarter and prompted contagion fears across the asset class.
The Bloomberg Barclays U.S. Aggregate Index ended the quarter flat at 0.02%, while the Bloomberg Barclays U.S. High Yield – Corporate Index finished up 2.40%. U.S. Treasury yields rose over the past three months, with shorter-maturity Treasuries rising faster than longer-maturity Treasuries, leading to a further flattening of the yield curve. This is a trend worth watching, as an inverted yield curve has historically been a leading indicator of a forthcoming economic recession.
Oil prices rose during the quarter, with WTI crude oil futures closing September at a little over $73 per barrel. These higher oil prices reflect angst in the market about tightening global supply. Case in point: OPEC and its allies decided in September to maintain current production targets, despite looming U.S. sanctions on Iran — which are expected to severely curtail oil exports from OPEC’s third biggest oil producer. Despite the U.S.’s growing production capabilities — Texas, by itself, is expected to soon become the third largest producer of crude oil in the world — increased production from key OPEC member and non-member nations (i.e., Saudi Arabia and Russia) would likely be required to compensate for the lost supply from Iran. These potential supply issues prompted concern that crude oil prices could reach $80 per barrel or higher over the coming months.
Tariffs and trade policy remained in the spotlight throughout the third quarter. While no country is immune from President Trump’s push to improve the U.S. trade deficit, China has by far attracted the most attention from the President. In September, the U.S. imposed a fresh round of tariffs on $200 billion worth of Chinese goods. With these new tariffs, which began at 10% but are scheduled to increase to 25% at the beginning of 2019, the U.S. has now levied tariffs on nearly half of all Chinese imports into the country — roughly $250 billion worth of goods. China quickly retaliated, announcing new tariffs on an additional $60 billion of U.S. goods. Despite significant progress that was made this quarter with other trading partners — trade agreements with Canada, Mexico and South Korea, ongoing dialogue with Japan, the U.K. and the European Union — the escalating trade war with China will likely continue to dominate trade-related headlines for the foreseeable future.
U.S. unemployment continued to garner positive headlines during the quarter, as jobs were added to the U.S. economy in each of July, August and September, further extending the longest streak of job growth on record. The unemployment rate fell from 4.0% at the end of June to 3.7% at the end of September, hitting its lowest level in nearly 50 years. Wage growth accelerated a bit during the quarter, hitting 2.9% in August — the highest since 2009 — but ending September at an annualized rate of 2.8%. Despite the increase over the quarter, wage growth has been relatively anemic considering the economy is at — or very near — full employment. Interestingly, after adjusting for inflation, wages today have the same approximate purchasing power as wages 40 years ago, according to the Pew Research Center. Wage growth is an important metric to watch going forward, as strengthening wages could drive inflation and pressure the Fed to hasten the pace of interest rate hikes — increasing the probability of a Fed mistake (tightening too quickly or too much), a scenario that GuideStone has previously stated is a key risk to financial markets.
As expected, the Fed raised the Federal Funds rate at its September meeting, increasing it by 0.25% to a new target of 2.00% to 2.25%. With strong employment data and wage growth apparently accelerating, the Fed is on pace for a fourth rate hike in December and is projecting an additional three increases in 2019. In addition to gradually increasing interest rates, the Fed is continuing to unwind a balance sheet that, at its peak, touched $4.5 trillion. The balance sheet reduction process involves the Fed letting maturing mortgage-backed and Treasury securities “run off” instead of reinvesting the proceeds into new issues. This runoff began in October 2017 at a pace of $10 billion per month and has steadily risen by $10 billion every few months. October 2018 marks the Fed’s final scheduled increase, to an amount of $50 billion per month. While officials have not publicly stated a long-term target level for the Fed’s balance sheet — this will be determined, at least in part, by prevailing economic conditions over time — many industry observers expect the runoff process to take a handful of years.
Looking forward, economic growth and corporate profits are expected to remain on solid footing, buoyed by the Trump tax cuts and ongoing regulatory relief. These positives, however, are offset by tightening financial conditions and uncertainty surrounding both trade and the upcoming midterm elections. Our outlook remains one of caution — while we anticipate a positive market environment over the near-term, U.S. equities are demonstrating clear signs of late cycle behavior, volatility is increasing and investor risk appetite is beginning to fall. As mentioned above, we believe tighter monetary policy is a key risk for financial markets and will eventually become a headwind to continued growth.
In times of uncertainty, it is important for investors to be appropriately diversified and remain committed to their long-term investing strategy. GuideStone works to identify opportunities and risks in financial markets and is well-positioned to make opportunistic moves within the Funds in anticipation of, or in response to, specific market events or changing market conditions. As always, we do not recommend trying to time the market.
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