The third quarter of 2019 was another choppy one for financial markets as investors continued to weigh the overall health of the global economy against a host of uncertain macro factors. Uncertainties included the ongoing trade war with China, a drone attack on Saudi Arabia’s oil fields, the seemingly never-ending Brexit negotiations, and—as September wrapped—an official presidential impeachment investigation in Washington, D.C.
On the economic front, the Federal Reserve followed its 25-basis-point interest rate cut in late July with another 25-basis-point cut in mid-September. This was in response to the weak global economic environment and the impact of trade policy on U.S. business sentiment and capital expenditure. The European Central Bank also cut its policy rate and announced it would launch a new open-ended asset purchase plan (i.e., quantitative easing, or QE) starting in November.
Amidst this backdrop, equity markets rose in July, fell in August, then rallied in September. Large-cap U.S. stocks gained 1.7% for the quarter and have netted over 20% year to date. Smaller caps suffered more acutely during the market drops and ended the quarter down 2.3%. For the year to date, small-cap stocks are still up a healthy 14.1%.
Despite a rebound in September, foreign stocks posted negative returns for the quarter. Developed international stocks were down 0.9%, European stocks were down 1.8%, and emerging-market stocks lost 4.1%. The U.S. dollar appreciated 2% to 4% versus other currencies during the quarter, which in turn created an equivalent drag on foreign stock market returns for dollar-based investors.
Bond yields around the world continued to move lower in the third quarter as deflation concerns took hold. The benchmark 10-year Treasury yield dropped to below 1.5% in early September as trade war and recession fears crescendoed. It then sharply reversed, then dropped back, ending the quarter at 1.68%, down from a 2% yield at the end of the second quarter.
U.S. core investment-grade bonds were flat in July, rallied sharply in August, then dropped in September as interest rates rebounded from historic lows. For the full quarter, core bonds gained 2.4%. Floating-rate loans returned 1.0% and high-yield bonds gained 1.2%. Core municipal bond funds were up a little over 1%.
U.S. stock and core bond holdings performed well for our balanced portfolios, while the returns for other asset classes were choppy. Portfolio performance was aided, though, in September when interest rates moved higher, catalyzed by an apparent détente (at least for the time being) in the U.S.-China trade war.
The economic environment continues to seem like a game of tug of war between the contractionary effects from U.S. trade policy and accommodative/expansionary global monetary policy. We see two widely divergent, if not binary, market outcomes—a recessionary event or a cyclical rebound. Portfolios should be resilient in either scenario. We recently upgraded the quality of our fixed-income holdings in some portfolio strategies upon consideration of several data points that were signaling recession concerns. But there could very well be a cyclical rebound that extends this cycle, in which case we’d expect our allocations to international and U.S. value stocks to perform well given their greater sensitivity to global growth. Our holdings in those areas balance the defensiveness we have in place on the bond side.
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