U.S. equities hovered near record highs towards at the end of October as investors saw positive signs across the latest earnings and economic data while the trade talks between America and China remained muted. Ten-year Treasury yields hit their highest since September, oil rose once more, and gold slipped below $1,500 an ounce.
This comes as no surprise as the month ended with the U.S. service industries expanding more than forecast in October; the economy added 128K jobs in the month easily beating the estimates despite a decline of 42,000 jobs in the autos sector due to a General Motors strike that has now been settled. Jobs growth data for September and August was also revised substantially higher. September’s number was revised up to 180K from 136K, while August jobs growth was revised to 219K from 168K.
This all came after the Federal Reserve cut rates earlier in the same week by 25 basis points. The Fed also signalled a higher bar for further rate cuts, but noted significantly higher inflation is needed before raising rates again. This has put investors in a more bullish mood lately. Around 70% of S&P 500 companies have reported quarterly numbers thus far, according to FactSet. Of those companies 75% have reported better-than-expected earnings.
It wasn't all good in US alone, as the world's biggest exporter, China, also provided the markets some fuel as China’s central bank reduced the cost of one-year funds to banks for the first time since 2016, easing concerns about tightening liquidity, while Bank of Japan suggested his nation could issue more super-long term bonds, reflecting a desire for a steeper yield curve. Japanese shares led gains as Tokyo traders caught up after a long weekend, with more modest advances in Shanghai, Hong Kong and Seoul. Australia’s dollar also rose after its central bank left interest rates unchanged and said past easing steps are offering support.
However, we believe market is still not pricing in the broader economic story. Unemployment data might be showing strength at this point but the US Q3 GDP figures showed a marked slowdown year over year compared to Q3 2018. Real GDP growth has slowed this year from 2.9% to 1.9%. Personal consumption has slowed from 3.5% to 2.9%. Services have slowed from 3.4% to 1.7%. And gross private investment slowed from 13.7% to -1.5%.These shifts are all warning signs, and all these data points matter for the future of employment in the US.
Simply put, slowing economic growth at the end of a business cycle is practically an obvious indicator for companies to tighten things up; reduce those overheads and improve efficiencies as profit margins get squeezed. This hasn't happened yet of course, but there are winds of change and we believe investors need to be vigilant in looking for signs of a shift. Looking at history, the shift in cycle comes suddenly and so will the move from low unemployment to higher unemployment.
For a recession to be imminent, one would want to see at least an uptick in initial jobless claims, which hasn't happened yet and the data continues to show promise. So we can expect the companies to be able to absorb profit margin pressures without having to resort to layoffs. However, there has been a slow down in jobs growth, especially on the private side. The private payroll growth has slowed significantly in 2019 to barely above 1.5%, as companies appear much more cautious about adding new positions, amidst larger uncertainty in the global economy.
Lastly, something else that is also missing the headlines is that, for the first time, the size of the working-age population is shrinking. Structural demographic factors are at play here, as baby boomers are retiring and birth rates have been decreasing. Although this story has two sides; the upside being, companies may find it harder to find replacements for retiring baby boomers, which may ultimately help with disposable income growth. The downside is that retirees tend to spend less, and this fundamental demographic shift could have a lasting stagflationary impact on the US economy.
While investors can continue to take comfort in low unemployment and low initial jobless claims, we believe that the all economic indicators have to be closely watched for signs of change, as these changes may come rapidly and with little notice.
Head of Investment Research