The U.S. economy continues to display strength, by traditional measures, even as other developed nations show signs of struggle. However, as the September 1st deadline for additional tariffs on China edged closer, investor concerns grew regarding the economic impact of trade tensions. Domestic strength continues to be spearheaded by the consumer, who remains confident and willing to spend. Fueling this confidence are historically low unemployment rates across all demographics and continued low inflation. The unemployment rate ticked slightly higher during August to a still remarkable 3.7% while inflation hovers around 2%. Whereas the consumer remains robust, manufacturing continues to soften as the ISM Index dipped to 49.1, below the neutral 50 mark for the first time in three years and indicating a minor contraction of activity. Although both the U.S. and China are dug in on trade negotiations, China has much more to lose. Trade with the U.S. represents a vastly greater portion of China’s economy than vice versa, and evidence shows that many U.S. suppliers are moving manufacturing out of China. Hopefully, this leads China back to the table and to an end of the trade war. Until then, the Federal Reserve appears poised to continue their easing path, with three more rate cuts expected and priced into bond rates.
The stock market experienced broad-based weakness in August with all major equity indices posting negative returns. The selloff occurred despite corporate profits continuing to show strength, with second quarter earnings for the S&P beating estimates by 5%. Instead, equity investors, nervous about the economic impact of the trade dispute with China and the recession indication of the inverted yield curve, reduced exposure in favor of less volatile investments. The defensive sectors of Utilities (5.16%), Real Estate (4.87%), and Consumer Staples (1.80%) performed as the environment would dictate, posting positive results. All other sectors were in negative territory with Financials (-4.85%) and Energy (-8.07%) losing the most value.
Fixed income investment returns were driven by anticipation of Federal Reserve policy decisions during August. As rhetoric about rate cuts accelerated, bond purchases focused on mid to longer maturity debt, especially for Treasuries, driving yields downward. Yields for 30-year Treasuries declined by 56bps to 1.96% while the ten-year declined by 52 bps to 1.50%. Shorter debt, like the 3-month T-bill and the 2-year note declined much less, by 6bps and 37bps. August ended with 10-year Treasuries yielding 1bp less than 2-year and 48bps less than the 3-month bill. This inverted yield curve has historically been a foreteller of upcoming recession. With this aggressive buying in the bond market, returns were positive across major domestic indices.