During the third quarter the S&P 500 continued to build on its strong 2019 performance. The market-capitalization weighted index gained 1.7% bringing year-to-date total return to 20.5%. Much of the third quarter returns were given up in the first few trading days of the fourth quarter as concerns of an economic slowdown pressured stock prices. The Institute of Supply Management (ISM) manufacturing September index fell 1.3% from August to 47.8%. This is the second consecutive monthly reading under 50 and represents a contraction in the manufacturing sector. Comments from the ISM’s panel reflected a decrease in business confidence with global trade cited as the most significant issue.
While slowing manufacturing sector data is a concern and manufacturing is an important piece of the U.S. economy, it doesn’t carry as much weight as it did in the past. The most important piece of the U.S. economy and the largest percentage (68%) of U.S. gross domestic product (GDP) is the consumer and consumer spending is strong. The 3.7% unemployment rate is the lowest since our 1969 moon landing and workers are starting to see wage growth above 3.5% for the first time since 2007. With more people working and earning higher wages, consumer spending generally increases. The consumer balance sheet is also in great shape with U.S. household net worth approaching $115 trillion dollars (Yes, that is a T). The household debt service ratio, debt payments as a percentage of disposable income, is at an all-time low of 9.7%. In the second quarter, consumer spending increased 4.6% and accounted for 150% of the 2% real GDP growth. Adding government spending (17.5% of U.S. GDP) which grew by 4.8% in the quarter tells us that 85% of our GDP grew by more than 4%.
What does this mean for our economy? If consumers remain resilient and federal and local government check books remain open, a significant decline in business investment would be required to produce a recession. With concerns of slowing global growth and uncertainty over trade, businesses are reticent to invest and many have slowed capital expenditures. Even with negotiations resuming on October 10, a long-term trade deal between the U.S. and China does not look likely in the near term. The more likely scenario, an interim trade deal, could give businesses the clarity they need to start investing again and would likely boost investor sentiment.
What does this mean for the U.S. stock market and investors? History tells us that the path of the economy and the stock market are not necessarily correlated. Just last year the S&P 500 fell by 20% during the fourth quarter while real GDP grew 2.2% in that quarter and 2.9% for the year. Stock market corrections and bear markets often reveal investors with poor or nonexistent investment plans. In contrast, successful investors first identify their willingness and ability to take investment risks. Controlling investment risks is inherently part of LVM’s research process. Eliminating companies with poor fundamentals and balance sheets is designed to help avoid poor quality and overpriced value-destroying companies. Owning shares of individual companies allows us to invest capital on a returns-based process and for clients’ specific portfolio objectives versus allocating based solely on what exists, i.e., market capitalization.
David P. Cleveland, CFA Tyler W. Alvord, CFA