Giving Thanks

As November closed, investors could give thanks for solid risk asset returns as well as surprisingly solid returns from risk control assets, with global equities having posted a nearly 23% return year-to-date and U.S. bonds having gained almost 9%.1 And what a difference a year makes: This time last year, U.S. Federal Reserve Chairman Powell declared interest rates “far from neutral,” sending equities into sharp decline.

Here are five key takeaways for the month:

1

Market Pulse

Living to Fight Another Day

Developed market equities rallied in November, overcoming growing geopolitical headwinds and lackluster corporate earnings results as investors embraced the growing consensus that recession fears had been wildly overblown. Interest rates across the developed world rose, with the 10-year Treasury yield reaching 1.94% mid-month, significantly higher than the closing yield of 1.52% on October 4. With the global economic cycle living to fight another day and the U.S. yield curve “un-inverting,” global sentiment was decidedly risk-on. However, persistent uncertainty over the phase one U.S.-China trade deal had a meaningful impact on daily market moves.

Solid Returns Across the Board

Asset Class Returns

Source: Morningstar Direct. All returns shown on a U.S. dollar basis

2

Macro View

The Tariff Man

“The Tariff Man” paid us a visit in November as U.S. President Trump continued to play hardball with China and re-imposed steel and aluminum tariffs on Argentina and Brazil. Most recently, President Trump has threatened to also impose tariffs on a broad array of French imports, including cheese, champagne, handbags and beauty products. These tariffs are clearly in retaliation to a recently imposed online services tax aimed squarely at some U.S. tech giants, such as Google and Amazon.

Tariffs have become the economic weapon du jour, and we expect this to become a more persistent state going forward. Also, we view reaching any broadly meaningful trade deal – particularly between the U.S. and China – as unlikely, with the current U.S. administration continuing to prove itself an unpredictable trade counterparty. The most important element of a phase one deal is avoiding the new round of tariffs on Chinese goods set to take effect in December. If imposed, they would hit U.S. consumers at a point in time when the economy is heavily reliant on their health amid continued manufacturing weakness. We still hold out hope that a phase one deal will be struck; however, further progress will be difficult.

3

Policy Front

The Bar Is Set High

In November, the U.S. Federal Reserve cut interest rates for the third time this year, seemingly completing this round of “insurance” cuts. While economic growth in the U.S. remains positive, inflation continues to undershoot, creating a conundrum for the Fed, given its dual mandate of full employment (check!) and well-anchored inflation around 2%. Currently, 5- and 10-year inflation breakeven rates sit at 1.55% and 1.67%, respectively – well below target. It is important to note that this is a global phenomenon; inflation has undershot central bank targets persistently, with the 2% target seemingly unattainable on a consistent basis.

Recently, the Fed has begun internal discussions about modifying their mandate to allow for a more credible, symmetric inflation target. Under this change, the Fed would allow periods of persistent undershooting, such as the current period, followed by periods of overshooting, without the typical central bank response. This is aimed squarely at re-setting inflation expectations higher. Nonetheless, we continue to believe that a sustainable reset remains challenged by structural inflation headwinds: most notably, high levels of global debt, demographics and increased use of technology.

4

Fundamental Focus

A Closer Look at High Yield

There has been growing concern about leverage, or debt levels, particularly among U.S. companies. The favorable rate environment, coupled with the search for yield, presents an ideal environment for debt financing and has led to record corporate bond issuance in 2019.

Over the last several months, we have seen some signs of stress in the lowest rated corporate bond market, with CCC rated spreads rising to more than 11% as investors begin to reprice risk in this area of the credit market. This has led some to question our continued commitment to high yield bonds for client portfolios. However, our base case outlook provides a constructive environment for high yield credit, with slow-but-positive growth, low inflation and the possibility that the Fed could lower rates in 2020. We view default risk as remaining low in this environment. Further, the technical outlook is similarly constructive, with robust yield-seeking demand standing ready to absorb planned issuance.

5

Segment Spotlight

Merger Mania?

More than $70 billion in merger deals were announced in the last week of November, bringing the year-to-date total to $3.4 trillion and reinforcing a growing global theme in the market. Some investors point to this merger and acquisition (M&A) boom as signaling the top of a market or business cycle. However, we are not quite ready to draw that conclusion, as we see the deals as strategic. For example, the merger of Charles Schwab and TD Ameritrade confirms the need for scale in a zero commission world. Similarly, the combination of LVMH and Tiffany reflects the reality that combining resources amid the challenges of slowing global growth makes sense for luxury goods companies. That said, we are mindful of growing challenges in the leveraged loan market, a key source of financing, and we are seeing a growing percentage of deals financed with equity, including the Schwab-TD Ameritrade deal.

Finally, we are watching valuations closely. Currently, companies are paying about 22.5 times net income, down from last year but still the second highest level since 1998. In an environment of persistently low interest rates and slowing growth, this level appears elevated, but likely reasonable. Further, this level of activity affirms our base case view that growth will continue at a moderate, albeit uninspiring, pace.

  1. As measured by the Bloomberg Barclays U.S. Aggregate Bond Index.

Disclosures

This information is not intended to be and should not be treated as legal, investment, accounting or tax advice and is for informational purposes only. Readers, including professionals, should under no circumstances rely upon this information as a substitute for their own research or for obtaining specific legal, accounting or tax advice from their own counsel. All information discussed herein is current only as of the date appearing in this material and is subject to change at any time without notice.

The information contained herein, including any information regarding specific investment products or strategies, is provided for informational and/or illustrative purposes only, and is not intended to be and should not be construed as an offer, solicitation or recommendation with respect to any investment transaction, product or strategy. Past performance is no guarantee of future results. All material has been obtained from sources believed to be reliable, but its accuracy, completeness and interpretation cannot be guaranteed.