- Although U.S. stocks are up so far this year, the global economy remains vulnerable and recession fears have increased.
- The outcome of U.S.-China trade negotiations likely will have a strong impact on economic and market direction.
- Discipline around diversification and rebalancing remains important for investors.
As we head into the final months of 2019, U.S. equities have performed positively, with the S&P 500® index up about 20% year to date.1 However, most of that gain occurred early in the year, as stocks rebounded from a sharp drop in late 2018. Stock market action has been choppy since then.
U.S. job growth has been solid and consumer spending has continued to support U.S. economic growth. Yet at the same time, U.S. and global manufacturing are in recession territory. Many countries’ interest rates are negative, as central banks in Europe and Japan struggle to stimulate borrowing, investment and growth. Recession chatter remains elevated, particularly as sections of the U.S. Treasury yield curve have been “inverted”—that is, long-term rates became lower than short-term rates—on and off since March.
Our 2019 Market Outlook theme was “be prepared,” and that remains our advice. Here’s what we expect to see for the remainder of the year:
Uncertainty over the U.S.-China trading relationship will continue to affect economic growth and markets. The ups and downs of U.S.-China trade talks have weighed on market sentiment and posed the biggest challenge to confidence and the economy so far in 2019. Although the U.S. has trade deals signed or pending with Japan, South Korea, Canada and Mexico—four of its top seven trading partners, accounting for a combined 60% of U.S. trade—it’s the dispute with China that has continued to grip markets. China, formerly the U.S.’s biggest trading partner, slipped to third place in the first half of this year, according to the Commerce Department.
U.S. and global recession risks may remain elevated. The three-month/10-year Treasury yield curve inverted in March, and the two-year/10-year curve inverted in August. Because yield curve inversions historically have often—but not always—preceded a recession, this has raised concern that a recession is on the horizon. However, other commonly watched indicators, such as corporate credit yields vs. Treasury yields, are currently showing a very low probability of recession.
It’s worth noting that even if a recession does occur, over the past 50 years the time lag between inversion and recession has varied widely, from five months to 23 months. Stock market performance following an inversion also has been mixed.
Source: Charles Schwab, Bloomberg, National Bureau of Economic Research (NBER). For illustrative purposes only.
An attack on Saudi Arabian oil facilities in mid-September has raised the possibility of a sharp and sustained rise in oil prices. If that should happen, it would be a shock at a bad time for a vulnerable global economy. Historically, recessions often have followed oil-price spikes.2
Earnings growth may continue to slow. After rising more than 20% in 2018, year-over-year S&P 500 earnings growth was slightly positive in the first and second quarters but is expected to turn negative in the third quarter.3 The next two quarters’ expectations, as well as next year’s, will be key to watch in light of the consumer-goods orientation of the tariffs currently scheduled to kick in on Chinese imports in December.
Treasury yields are likely to be lower for longer. In August, the yield on the benchmark 10-year Treasury bond reached a three-year low below 1.5%. While slowing global economic growth, tame inflation and ongoing trade uncertainty make it probable the Federal Reserve will continue to cut short-term rates, the direction of longer-term yields depends on what comes afterward. If the economy strengthens, 10-year Treasury yields may rebound, but further economic deterioration could drive yields even lower.
What investors can consider now
- Discipline around diversification and rebalancing remains very important. Recession risk is rising, and stocks historically have posted their weakest performance during the six months leading up to recessions.
- We strongly recommend rebalancing your portfolio back to its long-term asset allocation targets, if it has been a while since you last did so. Rebalancing means buying and/or selling assets to return your portfolio weightings back to their original desired levels—for example, 60% stocks/40% bonds. If you’re not sure how to do this, a financial advisor or a Schwab Financial Consultant can help.
- U.S. large-capitalization stocks continue to be preferred over small-cap stocks. Overall, small caps tend to underperform later in the business cycle, have weaker profit profiles, are less nimble with regard to tariffs, and have higher debt ratios.
- Don’t overlook the importance of diversification within the international portion of your portfolio. Correlations among the stock markets of the G20 countries (that is, the extent to which they move in tandem) have fallen to levels not seen in 20 years, enhancing the potential value of global diversification.
- Within your fixed income portfolio, we strongly suggest moving up in credit quality. Volatility may increase in the riskier parts of the market, such as high-yield bonds, if economic growth slows and it becomes harder for less-creditworthy borrowers to make interest payments. Even within investment-grade bonds, consider moving to the higher tiers of credit quality.