Published on Oct. 21, 2019
Third Quarter 2019 Equity Commentary
Stocks moved higher during the 3rd quarter, as the S&P 500 returned just over 1% for the period. Though modest in absolute terms, these gains were generated amid heightened political and geopolitical tensions, and uneven economic conditions both in the US and abroad. While we think that risks remain elevated, there are reasons to believe that stocks may continue to be resilient moving forward.
The announcement of the formal impeachment inquiry against President Trump may have been the biggest global news story of the 3rd quarter, although we do not necessarily expect that this will have an outsized impact on capital markets. While the sample size is quite limited, historically presidential impeachments have not derailed stocks. Moreover, while the odds of impeachment by the House of Representatives do appear to be rising, we do not expect that the Senate, with its Republican majority, would convict and remove the president from office. Nonetheless, this does appear to be a very fluid situation, and it is certainly possible that new information may come out which could change this calculus.
We think that any impeachment related impact to the stock market would most likely result from the effect that the hearing could have on Trump’s re-election prospects. If it were to hurt his campaign and raise the odds of an ostensibly less business-friendly Democratic candidate, we think stocks could have some downside. However, some political pundits are making the case that an impeachment could actually help President Trump’s re-election campaign, insofar as the hearings re-energize his base. While that remains to be seen, our initial analysis is that an impeachment is unlikely to be a major headwind for capital markets.
Geopolitical tensions were elevated during the quarter, particularly in the Middle East, after the attack on Saudi Arabia’s 2nd largest oil field and largest crude processing plant. The damage initially took out about half of the country’s oil production, though most of it was back online in relatively short order. While crude prices surged on the news, they have since subsided to the point where they are now modestly below the levels preceding the attack.
In our view, it is noteworthy that the incident did not have more of an impact on global markets. We believe that had this occurred several years ago, it likely would have led to much higher oil prices, and we think that this reflects a couple of factors. From a cyclical perspective, the slowing global economy likely mitigated a sharper, longer lasting spike in energy prices. Perhaps more significant though is the secular change in oil production, where the US has now emerged as the swing supplier of crude rather than Saudi Arabia. As a result, it may be the case that future geopolitical incidents in the Middle East have less of an impact on energy markets than they have had in the past.
The trade war between the US and China continued to be a focal point for investors as both countries announced their intentions to levy additional tariffs during the 3rd quarter. However, over the last few weeks there have been some encouraging signs. Chinese companies have made material purchases of US pork and soybeans, and President Trump temporarily delayed the implementation of a tranche of tariffs that were set to go into effect on October 1st. While the delay is only for two weeks to October 15th, it still appears to be a modest gesture of goodwill and it allows for continuing negotiations in the interim. The situation remains fluid and highly difficult to predict, but the fact that the economic growth in both China and the US appears to be slowing may create a greater sense of urgency on both sides to get a deal done, which would likely be well received by capital markets worldwide.
Turning to the US economy, the manufacturing sector continues to struggle. The Institute for Supply Management’s manufacturing survey fell below 50 for the first time in recent years in August, and the index deteriorated further in September. The GM strike and Boeing’s challenges with its 737 Max are company-specific factors which may be contributing to this weakness, though more generally it’s likely that the slowing global economy, the trade war with China, and the strong dollar have been the most significant industry headwinds. There have been some bright spots though. Housing appears to be gaining momentum as recent releases on starts, existing and new home sales, and pending home sales have all exceeded analysts’ expectations. Moreover, the service sector appears to be holding up relatively well. Given its far larger contribution to GDP, this appears to have helped the overall economy continue to grow despite the weakness in manufacturing.