October 10, 2019


Dear Investor,


While efforts to remove a dangerous President proceed in Washington, signals point to a sure slowdown in economic activity. Whether this leads to recession now or later is the only question. Given the pain recessions cause to millions of people, they can’t be wished for. But since they are inevitable, better to have one within a year to help drive this President from office.

Economic predictions exist to make weather forecasts look respectable, as they say, so the efforts to predict the timing of a recession are useless. And efforts to predict market movements around recessions are worse than useless. But looking at one measure proves GDP is already contracting.The ISM manufacturing index, which registered 47.1 in September (down from 49.1 in August) says the US is making less stuff than it was. Any number below 50 signals contraction, and this is the worst number since the last recession. If we are not already in recession, we are getting close.

It’s possible that the bear market in the last quarter of 2018 was presaging this recession. Barely a blip of a memory in most investors’ brains, the 2019 decline took stocks down 19.8% from October to December last year. Only because it missed the last two tenths of a percent (that would have made it an even 20%) did it escape being anointed an official bear market by the press. The recovery in stocks this year also helped bury the memory.

The seesaw action of U.S. stocks has obscured a fact that becomes obvious only when you look at the return over the past twelve months: they have stalled out. The one-year return on the S&P 500 is just 3.37%, half of which was delivered by dividends. Prices have gone virtually nowhere in a year. 

Meanwhile, emerging market stocks (as measured by the Schwab Emerging Markets ETF, the SCHE) have increased 5.13%. For the first time in several years, international stocks are leading domestic ones. The valuation gap was just too large: what was cheap is finally eclipsing that which is too expensive. This sea-change in market leadership has gone unrecognized by most commentators, especially as it is obscured by calendar-year returns. But make no mistake: it is finally happening.

Even with unprecedented peril in Washington, trade wars raging, and a recession taking hold nationwide, investors should continue holding larger-than-usual emerging market positions, which sport a dividend of 3% and should easily beat both bonds and domestic stocks over the coming years.

With best wishes for the coming quarter.