Two years in a row, September has proven to be less bad for stocks than its infamous reputation warned. The S&P 500 gained 1.9% last month, which was enough to push the index just into the black for the quarter. For the year, the S&P 500 has gained 20.6%. That’s exceptional performance, to be sure, especially within the context of ongoing trade spats with China and now our European trading partners. It’s also a little misleading – recall that the broad markets started the year at depressed levels after declining almost 14% in the fourth quarter. In a sense, markets are merely back to levels reached at the end of last September.
In a very real way, stock valuations have been “correcting” for almost two years because prices are roughly flat while underlying earnings have increased. At current levels, the overall market is fairly valued – certainly not overvalued or expensive. Economic and corporate fundamentals remain very supportive of stocks even after a decade-long bull market. Any softness in the recent data (e.g. the last manufacturing ISM number) is likely attributable to uncertainty on global trade, not the start of a contraction in the U.S. Judiciousness on the part of multinational company CEOs argues for some degree of hesitation until material trade rules are formalized. Almost 70% of the domestic economy is driven by consumer spending and services, not manufacturing, and the American consumer seems to be in terrific shape. While global industrial companies lacking clarity on trade might be pulling back, the spending patterns of consumers appear less affected by the uncertainty.
Day-to-day, markets will gyrate to headlines on trade negotiations, but progress (or lack thereof) on that front does not change the fact that U.S. unemployment is at half-century lows, GDP is growing at 2% plus, interest rates remain low, and inflation is well under control. We share Fed Chairman Powell’s view that this economic backdrop feels “sustainable.” If he’s right, higher stock prices (from current levels) would be supported by expanding corporate profits for a number of quarters ahead. In addition to “sustainable” current underlying economic momentum, we think markets can climb another wall of worry (regarding trade, profit growth, and the election) and reach new highs over the intermediate term.
It may seem more prudent to assume a recession and bear market is looming (and to take action), but the data don’t support that position or strategy. Recessions are not actionable investing events: the timing and length is unknowable; stocks typically discount recessions and decline in advance; no one rings a bell to signal all-clear; and most often we don’t declare a recession until after it has already ended. There are no term limits on economic expansions or bull markets, so age alone or duration shouldn’t be their undoing. (The opposite might be said for Congress!)