MARKET PERSPECTIVES

CitizensTrust A Division of Citizens Business Bank cbbank.com/investing

Donald Evenson Senior Vice President Chief Investment Officer

R. Daniel Banis Executive Vice President Head of CitizensTrust

2019 Third Quarter Equity Markets

2019, thus far, has been a good year for the U.S. economy and investment returns. U.S. equity markets were up slightly during the third quarter with the S&P 500 gaining 1.7%. The market is now up over 20% for the year and all three major indices are near their all-time highs. The tech-heavy NASDAQ index continues to lead the market this year, gaining over 21%. For the third quarter, large-cap stocks outperformed other segments of the market.

During the quarter, mid and small-cap stock indices were roughly flat, lagging large-cap stocks. International Developed markets, as measured by the EFA ETF, were down .79%. Emerging markets, as measured by the EEM ETF, were down 4.75%. Emerging Markets have lagged recently, hurt by a strong U.S. dollar and the trade dispute with China. Globally, it continues to be a good year for equities with the MSCI World Index up 16% year-to-date.

Equity investors have been focused on two major themes this year: the abrupt change in direction of Fed policy and the slowdown in manufacturing that is exacerbated by the trade dispute with China. Expectations of a comprehensive trade deal with China were dashed last May, and although negotiations continue in good faith, it does not appear that much progress has been made. With a U.S. election only 400 days away, it is unlikely that China will concede much in their discussions with the Trump Administration. The recently launched “impeachment inquiry” by the House should strengthen China’s resolve. While the S&P 500 did hit a new high in July, the tariff dispute appears to be limiting further equity gains as the market weighs the impact on profits and global trade.

Interest Rates

The Federal Reserve’s interest rate policy reversed course in the last quarter as it began to lower interest rates. The Fed cut its federal funds rate 25 basis points at both their July and September meetings. The Fed was responding to a slowdown in U.S. manufacturing and the relatively high U.S. rates in comparison with the rest of the world. In the

Fed’s most recent meeting, Chairman Powell stated that if economic data continued to worsen, the Fed would get more aggressive.

Historically, the Fed has typically gone too far in its tightening cycle or waited too long to respond to weaker economic conditions. In this case, the Fed changed direction in seven months. The combination of a previously “patient” Fed that may have waited too long and the slowing effect of the tariff dispute sent long-term interest rates down to their lowest levels since the summer of 2016. The 10-year U.S. Treasury bond yield fell as low as 1.47% in early September.

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not investment advice. The information is not offered with a product or service. This information is not intended to be a substitute for specific tax, legal, or investment planning advice. We suggest

that you discuss your specific questions with your qualified tax, legal or investment advisor.

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With longer-term rates falling faster than short-term rates, the yield curve inverted for the first time during this economic expansion. This is a sign that the markets are concerned about slowing economic growth. A global slowdown in economic growth has resulted in no less than 18 other central banks easing monetary policy and widening the differential with U.S. rates.

The Economy

U.S. GDP growth has been slowing in 2019 and that should continue in the third quarter. Leading economic indicators such as the ISM Manufacturing index and the LEI index point to a further slowdown. Estimates for third quarter GDP are currently hovering around 1.5%, roughly half the average rate for 2018 and the first quarter of 2019. Despite the slowdown, U.S. economic growth is strong relative to other developed nations. Europe, Japan and parts of Asia have experienced challenging growth environments due to many of the same issues. Relatively high U.S. interest rates have a strengthening effect on the U.S. dollar, which in turn puts further pressure on U.S. GDP growth by making U.S. goods more expensive to our trading partners. The strong dollar will continue to be a headwind for the U.S. economy.

It will take more time for recently lowered rates to have their full impact on the economy, but early signs of a response are beginning to show. Interest rate sensitive sectors, such as housing, have recently seen a pickup in activity. The drop in rates this summer pushed mortgage rates down to their lowest levels since 2017. The rate on a 30-year fixed mortgage has dropped over 1% since the end of 2018. This is positive for employment and for economic growth.

The U.S. consumer continues to be in good shape and is the backbone of the economy. One highlight of the recent jobs report was a solid pickup in wage growth. This is a byproduct of a low unemployment rate and tight labor

market. Corporate profits are strong, although growth has slowed from the double-digit pace of last year. S&P 500 earnings growth is estimated to be just 4% this year as the tax cuts of 2018 are annualized.

The Quarter Ahead

Investors will remain focused on tariffs and Fed policy in the quarter ahead. Negotiations with China are expected to resume on October 11th, and expectations of measurable progress are mixed. It has been a volatile back and forth, but stakes will go higher in the fourth quarter as U.S. tariffs are scheduled to increase further in mid-December. President Trump has stated that he would be happy to make a “good” deal, but he also likes the tariffs.

Fed policy is expected to ease further, with markets expecting additional rate cuts before year end. There are two more Fed meetings this year. The fourth quarter began with a weak ISM Manufacturing measure which fell to 47.8 in September, its lowest level since June 2009. The slowdown in manufacturing continues and is clearly exacerbated by the tariff dispute. Any resolution, even if temporary, would be positively received by investors. The USMCA trade agreement could also be passed in the coming months, which would be a net positive for growth. Eventually, U.S. companies will adapt to the new environment, even if it remains uncertain. In the meantime, the U.S. consumer and lower rates will have to do the heavy lifting for the economy.

We look forward to serving you and appreciate the trust you have placed in us. Please reach out to your CitizensTrust representative with any questions you may have.

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