Following a modest rally in July, August was volatile and weak, with the S&P 500 Index declining 1.8% to end the month at 2926.46, which is a 16.8% gain for the year to date, but well below the 20.8% gain at its peak in late July. The US economy is clearly slowing. GDP is rising at about a 2.0% pace as employment and household incomes continue to grow. Manufacturing is clearly in a recession reflecting the uncertainty emanating from the White House, as Trump wages a useless trade war against China, as well as soft exports due to the strong Dollar and weak foreign economies. Boeing's problems and the oil price decline are also weighing on growth. Further interest rate cuts by the Fed will not stimulate growth as long as the trade war with China goes on. The Chinese economy has clearly weakened, which is causing the European Union, particularly Germany, to fall into recession and Japan to stagnate. Despite this adverse macro backdrop, US corporations are managing to eke out modest profit gains. We are particularly pleased that virtually all of our portfolio holdings exceeded consensus estimates for second quarter revenues and earnings. At this point, the S&P 500 is valuing 12-month forward S&P earnings at 17 times, not particularly cheap, but not dangerously overvalued as long as the economy maintains a modest growth trend. If M2 continues to rise at much faster pace than nominal GDP, interest rates should remain low and financial market liquidity plentiful.
The market volatility emanating from Trump's trade policies, as well as some of the ridiculous reforms being proposed by various Democratic candidates for the White House, is magnified because trading volume in August is typically quite light, and therefore markets are extremely thin and price moves are exaggerated in both directions. The ETFs and the "algo" traders also increase daily volatility. We do not expect that the trade war with China will end until some time in 2020. Accordingly, the risk of a recession continues to rise. We have raised cash in our accounts and, for the moment at least, believe the amounts are suitable for the environment. If the macro backdrop looks to deteriorate further, we will not hesitate to add to our reserves. In the meantime, we are monitoring a short list of candidates for reinvestment, once the environment shows signs of improving.
