Fall is such a wonderful time of year with the shorter days and cooler nights, the glimpses of color in the yards and across the hillsides. Summer is officially over, the squirrels are busy storing away nuts and folks all around town are digging through closets, finding anew their jackets and overcoats.

Just as humans and animals are preparing for colder temperatures and winter storms we think investors should be prepared for market winds as economic growth slows in 2019 until it resumes in the second half of 2020. This slowdown, combined with political and trade uncertainties, will likely continue to buffet markets. The Federal Reserve has taken action to support economic growth with two cuts to interest rates in 2019 ¹. Lower rates have boosted bond prices and given equity investors reason to bid up stock prices despite challenges.

Our preferred indicator for US economic growth is the US Total Industrial Production index because it tends to lead GDP growth. This index has been trending down for the past two years ². We believe this points to US GDP growth slowing in late 2019 and resuming in the second half of 2020. We don’t believe there will be a recession during this time.

Political and trade issues top the list of investor concerns with impeachment proceedings here in the U.S., Brexit, and continued discussions around tariffs between the U.S. and China. These tariff discussions may be causing businesses to hold off on key investments as they wait to see how things will resolve.

The United Kingdom is awash with angst regarding Brexit, with much hand wringing and confusion as the latest deadline, October 31, draws near. Europe and Germany are grappling with an economic slowdown, partially caused by the uncertainties about tariffs and trade policy. The OECD estimates real GDP growth in the Euro Area at 1.1% for 2019, down from 1.9% in 2019 ³. Asian economies are moving forward but growth is slowing with trade policies weighing on growth. The OECD estimates real GDP growth in China to be 6.1% in 2019, down from 6.6% in 2018 ⁴. These lower economic forecasts have helped propel prices for U.S. companies ahead of international firms.

While uncertainties around the globe continue to be debated by economists and market pundits, the market advanced strongly through 2019. Major stock indices are up strongly while bonds have also moved up notably. Part of this advance has been a bounce back from the notable decline in the fourth quarter of last year. The Fed’s decision to lower interest rates throughout the year helped drive up the value of interest-producing investments such as bonds and real estate. It also appears to have given equity investors reason to bid up prices in hopes of further economic stimulus.

With uncertainties over tariffs and slower growth many companies have struggled to grow earnings over the past year. The S&P 500 has experienced three straight quarters year-over-year declines in earnings ⁵. Growth in corporate profits has also declined with the twelve-month moving total 11% below the year-ago level ⁶. These declines in earnings and profits highlight the impact of tariffs and the economic slowdown. We expect earnings and profits to rebound in 2020.

Valuations play a key role in determining medium-term stock price appreciation. Equity valuations are currently somewhat above historical averages but in line with historically low interest rates ⁷. We don’t believe that stocks are overvalued.

Given our expectations for market volatility, an economic slowdown, and continuing political tensions, we believe our strategy of focusing on smaller, less expensive, and more profitable companies will help portfolios navigate well. Indeed, value stocks have outperformed growth stocks since the beginning of August. ⁸

Since we can’t predict the future, we cannot know just which asset class will fare the best going forward. We can, however, hedge risk by holding different sorts of investments, some that tend to do better when skies are cloudy (bonds) and those that tend to do well in fairer weather (stocks) and, within those categories, we can (and do) diversify further in all sorts of ways.

Diversification won’t prevent our portfolio from losing value in times of duress, but it can certainly reduce the magnitude of those portfolio drops and help income and growth investors alike. For those taking income from their portfolio, bonds help by paying income and by acting as a repository for the cash flows needed to fund expenses. For growth investors, the diversified asset classes can hedge portfolio declines and provide for some ability to “buy low and sell high” as portfolios are rebalanced.

It is important to remember that the last 100 years has been a triumph for the optimists. Longer term, the natural trajectory has been one of growth and evolution, in the sciences, in society, from the standpoint of human well being and yes, even in the economy. Things are better now for humans than they have been in all recorded history. We, being somewhat optimistic folks, think this trend is likely to continue for the next 100.

Advisory services are offered by Summit Hill Wealth Management a Registered Investment Advisor in the State of Colorado.