Amid heightened volatility, markets turned this way and that in the third quarter, only to end up about where they started. Both the Dow and S&P 500 indexes gained a little more than 1%. Bonds, like stocks, also advanced modestly as the Fed continued to lower interest rates amid a soft economic outlook. Overseas performance was similar, although U.S. investors in foreign markets suffered small losses due to foreign currency denominated investments losing value when translated back into a surging U.S. dollar.
Trump’s trade war with China continued to move markets, but signals from each side about the progress of talks, or lack thereof, were more muted than in Q2. In any event, the impact of the trade battle has moved from the theoretical to the empirical – with the impact being felt globally as far away as Japan and Germany, two countries that are especially dependent on trade in manufactured goods. That sector has suffered more than any other (with the possible exception of U.S. agriculture), and may already be in a global recession.
Headline economic data in the U.S. remains respectable – GDP growth is estimated to be around 2% and the unemployment rate is just 3.5% - but trouble lurks beneath the surface. The September jobs report showed a loss in manufacturing jobs and, not coincidentally, a slowdown in the growth of wages. Businesses have clearly pulled back as the policy environment looks insufficiently stable to support significant long-term investment. Economists agree that growth is slow enough that political shocks are more likely than an overheating economy to lead to the next recession.
If it is going to be politics that precipitates the next recession, there is plenty to worry about. To trade wars and Brexit, we can now add the possible impeachment of President Trump. In just the past week, it has become increasingly likely that the House of Representatives will vote to impeach the President, probably before the end of the year. What happens next is highly uncertain. While virtually no one expects the Senate to convict and remove the President, public opinion on impeachment has moved substantially in the past week, and we shouldn’t pretend to know where it will be in a few months. If Republicans continue to stand behind the President no matter what, it’s hard to see any impact on financial markets or the real economy. On the other hand, we cannot rule out the possibility of even more damaging revelations to come.
But even if President Trump is removed from office, do we really know what to expect from markets? For a historical precedent, we have a sample size of just one. In Richard Nixon’s shortened second term the economy entered a recession and markets tanked. But it’s hard to pin that on Watergate. That period coincided with the Arab oil embargo and draw-down of forces from Vietnam.
As investors, we have no particularly useful precedent for the politics that lie ahead. But we do know that there will be a next recession. So should we hunker down now and get out of the markets? Unfortunately, we need to preserve a little humility here as well. We simply cannot say with confidence when the next recession will arrive any more than we can say what will cause it. Already, the imminent threat of a No Deal Brexit has lost almost all credibility, with Boris Johnson having an even more miserable past few weeks than Donald Trump. It is not hard to imagine the President, under the pressure of a slowing economy and a general election, taking another bogeyman off the table by declaring victory and striking a trade deal with China.
Even if our politics seem driftless, our financial lives need not be. Now more than ever it’s important to look beyond the next few months or even few years, to envision where we want to be, and to construct a plan to get us there.