Last week saw both stock and bond markets swing wildly due to questions around the future path of Fed policy, an unexpected depreciation in the Chinese renminbi, and uncertainty around trade. While manufacturing remains weak given the lack of clarity on U.S./China trade, it does not appear that a recession is lurking around the corner. That said, trade tensions look set to be with us for some time, and if that is the case, investment spending and manufacturing will remain under pressure. However, as long as the services sector and consumer remain healthy, this expansion should bend rather than break.
Recently, weakness in manufacturing has begun to infect the services sector, as evidenced by the lackluster July ISM (Institute for Supply Management) non-manufacturing print. With fundamentals less supportive, the direction of policy becomes even more important, and as such it is unsurprising that all eyes have been on trade. As long as there is uncertainty around the direction of trade policy, markets will be bouncy, and it looks like this could very well be the case through the 2020 election. But why does trade matter so much? Corporate profits and profit margins have risen steadily for 20 years as tariff rates have fallen and globalization has integrated supply chains. The risk is that this begins to come undone, threatening earnings and the outlook for global growth.
With markets set to remain volatile, what can investors do? First, they can add back some duration on the fixed income side, focusing on high quality government bonds that should provide protection if the outlook does in fact worsen. Second, investors should take a more balanced approach to equity markets, and focus on those sectors that have historically derived more of their total return from income. Finally, with real rates in negative territory, there is a need for long-term assets that can help portfolios grow. The key, however, is to focus on high conviction ideas that are supported by structural tailwinds. Perhaps unsurprisingly, many of these investments are tied to the technology sector.
In equities, focus on income as a source of return
Dividends vs. capital appreciation, 25-year annualized return, %
Source: FactSet, Standard & Poor’s, J.P. Morgan Asset Management. Data are as of August 9, 2019.