November 2019

“In the financial markets, hindsight is forever 20/20, but foresight is legally blind. And thus, for most investors, market timing is a practical and emotional impossibility.”

Benjamin Graham

Professor Graham, known as the father of value of investing, gave us many thoughtful, yet humble, investing insights. Profits cannot be earned with perfect 20/20 hindsight, but valuable lessons can be learned from the past to help shape foresight.

In the coming weeks, we’ll shift our focus to 2020, but first, let’s reflect on 2019. Last December, headwind risks from restrictive Fed policy and accelerating trade tensions caused markets to tumble to near bear market territory. Fast forward to today and:

  • The Fed has shifted from restrictive to easy monetary policy.
  • Trade risks remain but have de-escalated with a tenuous truce.
  • Political volatility is elevated, but legitimate policy risks are subdued for now.
  • Prospects for a trough in economic growth could encourage improving business conditions.
  • Strong U.S. consumers remain the bedrock of the global economy.
  • Double-digit market returns reflect an improving outlook that seeks validation.
  • Cautious optimism should be exercised, but complacency should be avoided.

In short, the robust market recovery we’ve seen in 2019 has been supported by fading economic headwinds as markets await renewed tailwinds of growth. We focus this month on economic and market reactions to recent developments.

Back to the Future with Fed Policy:

In 2019, the Fed borrowed a page from their easy money playbook. Simultaneous Fed rate hikes and balance sheet reduction in 2018 drained liquidity from the U.S. economy counterbalancing much of the anticipated benefit from the tax cuts. The chart below illustrates the shift in Fed policy since January 2018 when markets first began to convulse. The effective Fed funds rate rose from 1.4% to 2.4% by year-end 2018 where it remained until this summer. The three rate cuts we had in August, September and October this year brought Fed funds back to 1.5%, and the Fed balance sheet has once again expanded above $4 trillion after growing over $400 million in the last 90 days.

The 2019 reversal in Fed policy, has breathed oxygen back into the U.S. economy jumpstarting money supply growth and injecting liquidity into our financial system. Historically, when anemic money supply growth exceeds GDP growth by less than 2% (as it did from January 2018-July 2019) both GDP growth and stock prices tend to slump. The Fed typically responds by easing monetary policy and boosting liquidity, which has helped stock prices one year forward. In the 59 quarters since 1982 where money supply growth has narrowly exceeded GDP growth by less than 2%:

  • The Fed often intervenes with easier policy
  • Stock prices have been higher one year later 54 times (91% of the time)
  • Average S&P 500 returns one year later have been 15%


Fed stimulus since the summer has increased U.S. money supply, boosted liquidity and supported stock prices. This one metric alone cannot be used to forecast stock prices, but it helps explain the recent equity rally we’ve seen since August. This “mid-cycle adjustment” exemplifies a shifting Fed role where a rate cut cycle beginning at depressed rates is more of an economic insurance policy than it is incremental economic stimulus. In short, don’t fight the Fed.

Why China Matters:

The chart below cuts through the tariff chatter and goes straight to the heart of the matter. In the chart:

  • Red bars reflect each major trading region’s percentage of global GDP in 1989.
  • Orange bars reflect each major trading region’s percentage of global GDP in 2018.
  • Gray bars represent the percentage change from 1989-2018.

The story is straightforward. China is now an emerged market, and the growth of their economy is critical to the growth of the global economy.

  • Global GDP through 2018 (according to World Bank) is $85.6 trillion.
  • These four primary global trading partners currently comprise 67.5% of global GDP.
  • The U.S. and Europe have seen their combined share of global GDP shrink by 12.8%.
  • Japan has seen its share of global GDP shrink by 9.4%.
  • China has seen its share of global GDP grow by 14.2%, trailing only the U.S. for the country with the largest % share of GDP.

Current consensus GDP growth estimates for these four primary trading blocks are:

  • United States 2%
  • Europe 1%
  • Japan .5%
  • China 6%

To put these numbers into proper context when estimating global GDP growth, China’s expected incremental addition to the global economy for 2019 is more than the U.S., Europe and Japan combined. This is why trade and a potential slowdown in China matter. This is also why the current policy stimulus from the U.S. and China (combined 44% of global GDP) is a prerequisite for continued economic expansion.

Where do we go from here?

President Trump seeks a win prior to the elections and is motivated for a deal but not at any cost. President Xi seeks to curb any further deterioration in economic growth but doesn’t have the gauntlet of an election hanging over his head. Markets have accepted a new base case that incorporates a “phased in” deal rather than one “grand” deal. For now, the concept of a Phase 1 agreement has de-escalated trade war tensions but flare ups are only a tweet away. Risks remain as Dec. 15 tariffs are set to kick in if there is no Phase 1 agreement or extension. Current odds are roughly 50/50, but if tariffs are enacted, near-term market consolidation is a risk not currently priced into markets.

Markets Reflect the Manufacturing Cycle:

One of the most widely watched economic survey indicators is the Manufacturing Purchasing Managers Index (PMI). It samples business trends among purchasing managers that reflect expectations for business expansion, contraction or steady growth. The chart below illustrates a close relationship between the stock/bond ratio and the manufacturing PMI. For definition, the stock/bond ratio as shown below divides rolling annual S&P 500 total returns by rolling annual 10-year U.S. Treasury total returns:

  • When the stock/bond ratio is above 0%, stocks are outperforming bonds.
  • When the stock/bond ratio is below 0%, bonds are outperforming stocks.

The chart reveals that stocks generally outperform bonds when PMIs are in expansion territory (above 50) and bonds generally outperform stocks when PMIs are in contraction territory (below 50). In October, we saw PMIs inch up after six months of consecutive decline. Recent indicators have reflected similar trends in other parts of the world. Any new upward momentum would be cheered by markets.


Last month’s uptick in the manufacturing PMI is encouraging, but it’s too early to call it a trend. We’re hopeful renewed central bank easing and trade war de-escalation are beginning to improve business sentiment and will signal a bottom in global manufacturing growth that currently hovers near recession territory. A move back above 50 into expansion territory has historically front run positive stock market returns and any such move is likely to be led by the U.S.

Stock Performance During Previous Mid-Cycle Adjustments:

The Fed has signaled a pause in rate cuts with future actions to be data dependent. This mid-cycle adjustment we wrote about in June would be similar to the 1995 and 1998 adjustments when the Fed initiated three .25% rate cuts as an insurance policy against market weakness (1995) and economic instability (1998).

The chart below illustrates the performance of the S&P 500 (indexed to 100) from 90 days prior to the first rate cut in 1995, 1998 and 2019 to one year after the first rate cut. Given, 2019 is still a work in progress (blue dotted line), but so far, the S&P 500 continues to climb higher with a little help from the Fed mirroring the 95 and 98 cases. The S&P 500 climbed higher by 29% and 13% in 1995 and 1998 respectively, but we’re more focused on the direction of the market rather than the magnitude of the gain. This chart illustrates the old adage, “don’t fight the Fed.”

Bonds During Previous Mid-Cycle Adjustments:

The Fed has accomplished its most important near-term objective – the normalization of the yield curve. Three rate cuts and de-escalating trade conflict have supported an improving view for future economic growth. The yield curve now reflects this improved sentiment with a modestly upward sloping yield curve due to falling short-term rates and rising long-term rates since the maximum yield curve inversion on Aug. 28.

The yield curve is an important indicator of future growth expectations, but singular reliance on it in today’s low-interest-rate world could be problematic.

Bond returns have also been supported by extraordinarily narrow credit spreads. Investors demand compensation (higher interest income) for assuming credit risk with less than investment grade bonds. As the chart below shows, spreads become wide during times of distress like the shaded gray areas that denote recessions. However, today’s high-yield bond credit spreads remain below their 10- and 20-year averages, and default rates remain near record lows. We value this as more of an economic indicator than an investment opportunity in the current environment. If spreads begin to rise, we would interpret that as a signal of increasing economic stress in corporate debt that has ballooned in recent years. For now, risks are contained, but we’ll watch this closely as the expansion extends.

Final Thoughts:

Easier Fed policy and diminished trade tensions have been friendly to markets in 2019. We express cautious optimism for improving business conditions, but it’s too early to call the “all-clear” sign. Current market sentiment has followed stock prices higher and raised yellow flags for complacent investors in the near term. We believe stocks reflect better value than bonds for new allocations. Flat YTD earnings growth now seeks tangible signs of sustained economic growth to validate a move beyond the top end of a reasonable valuation scale, which we would place at an S&P 500 of 3275. (5% higher than today).

In the coming months, markets will watch and begin to price any legitimate policy risks. Focus on economic policy risk from 2020 elections will not be worthwhile until after the Super Tuesday primaries in March. Even then, risks to markets will need to be assessed from the vantage point of what is credible.

In closing, during this season of Thanksgiving, we’re always thankful for the relationships we enjoy with our clients, friends, colleagues and especially our families. We hope you enjoy a wonderful and memorable Thanksgiving with your family.

Thank you.

Jeff Terrell, CFA

Senior Vice President, Chief Wealth Market Strategist

Sources: Strategas, FactSet, Morningstar, Federal Reserve Bank, World Bank, U.S. Treasury, National Bureau of Economic Research, Institute for Supply Management

The Morningstar indexes are unmanaged, weighted indexes of stocks and bonds providing a broad indicator of price movements. Individual investors cannot directly purchase an index.

The opinions expressed are solely those of BB&T Wealth and don’t represent the opinion of BB&T Scott & Stringfellow/BB&T Investments/Sterling Advisors. This material is presented for general information only and is not intended to provide specific advice or recommendations for any individual. To determine what investments may be appropriate for you, consult with your financial advisor/financial consultant.

The information set forth herein was obtained from sources, which we believe reliable, but we do not guarantee its accuracy. Neither the information nor any opinion expressed constitutes a solicitation by us of the purchase or sale of any securities. Diversifying investments does not ensure against market loss, and asset allocation cannot eliminate the risk of fluctuating prices and uncertain returns. Past performance does not guarantee future results.