WHAT’S PAST IS PROLOGUE: THE MARKETS AND ECONOMY IN 2019
2018 marked the first time since the global financial The Link Between Main Street and crisis that the U.S. equity market posted a negative re- turn for a calendar year. After hitting an all-time high Wall Street in late September, the market traded lower through- The lifeblood of financial markets is the real econo- out the fourth quarter, punctuated by a record decline my. What happens on Main Street determines what of 2.7% on Christmas Eve. Analysts were quick to happens on Wall Street, although this causality re- blame the sell-off on a variety of reasons: fears that verses from time to time, such as during the global the Federal Reserve was raising interest rates too financial crisis. In the long run, however, economic rapidly, concerns over escalating trade conflicts with activity generates corporate revenues and corporate China, anxiety about slowing economic activity, profits, which in turn enables investors to place val- the looming government shutdown and so forth. ues on financial assets such as stocks and bonds. As Volatility spiked, and at year-end, pundits were quick the nearby graph illustrates, over longer periods of to declare the end of the bull market, with a recession time, the growth in these three variables – nominal Author almost certain to follow. gross domestic product (GDP), corporate earnings and stock prices – is remarkably similar, although the As the calendar turned to 2019, equity investors wel- volatility of this growth is vastly different. comed a recovery in stock prices. Yet the bounce leaves many investors slightly uneasy and suspi- GDP, Corporate Earnings and Equity Values cious that the worst may not be past. We readily 80% G. Scott Clemons, CFA acknowledge that our crystal ball is no clearer than Chief Investment Strategist 60% anyone else’s, and so we turn to history for insight Corporate Nominal GDP Growth (yoy) @GSClemons into what is likely to follow. In the pages that follow, 40%
we put recent market developments into context, in 20% 7.4% average
acknowledgment of Antonio’s observation in Act 2 of 6.4% average 0% William Shakespeare’s “The Tempest,” that “what’s 8.6% average Nominal GDP Growth past is prologue.” We can’t predict, but we can pre- -20% S&P 500 Change (yoy) pare, and history offers a guide. -40%
Source: Bureau of Economic Analysis, Standard & Poor’s and BBH Analysis. Data as of January 30, 2019. -60% 1955 1958 1961 1964 1967 1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006 2009 2012 2015 2018
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Nominal GDP (real GDP plus inflation) has expanded at an The point of this brief analysis is annual rate of 6.4% over the past 60 years, with a standard de- viation of 3.0%. This means that roughly two-thirds of the time, that price volatility is a feature of our nominal GDP has grown between 3.4% and 9.4%. Corporate earnings have expanded at an annualized pace of 7.4% over economic system, not a bug. Since the same period, a slightly better growth rate due to gains in productivity. Yet the volatility here is almost five times that of the S&P 500’s creation in 1928, the the underlying economy, reflecting cycles in corporate profit margins. When margins are rising, economic activity is mag- market has experienced an average nified in corporate earnings, and when margins are falling, the translation is diminished. of 17 days per year in which the in-
A similar amplification takes place when corporate earnings dex moved by 2% or more in a single translate into stock prices. The added dynamic here is the valuation cycle, which depends on interest rates and investor trading session. In 2018, the market sentiment, among a host of other influences. At different points in the past, the stock market has valued a dollar of earnings (as experienced 20 days with this level of measured by the price-to-earnings ratio, or PE) anywhere from $7 in the late 1970s to almost $30 at the peak of the 1990s volatility – right in line with the his- dot-com bubble. The average return of the equity market over torical average.” this same period is similar to economic and corporate earnings growth, at 8.6%, but with even more volatility.
The point of this brief analysis is that price volatility is a feature of our economic system, not a bug. Since the S&P 500’s creation in 1928, the market has experienced an average of 17 days per year in which the index moved by 2% or more in a single trading E Vo ati ity In e VIX session. In 2018, the market experienced 20 days with this level 90 of volatility – right in line with the historical average. In 2017, Financial crisis 80 however, the market had zero 2% trading days, only the 10th year in the past century without a single day of exaggerated 70 volatility. Volatility is normal. Stability is abnormal. 60 50 Flash crash U.S. debt downgrade The CBOE Volatility Index (VIX) offers a more sophisticated Chinese growth concerns U.S. growth 40 concerns measure of volatility by aggregating the implied volatility of 30 every stock option that trades on the Chicago Board Options Exchange. The price of an individual stock option requires mul- 20 tiple inputs, including the current price of the stock, the strike 10 Source: Chicago Board Options Exchange and BBH Analysis. Data as of January 30, 2019. price of the option, time left to the expiration of the option and 0 the expected volatility of the underlying stock. If we know all 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 the variables but one (volatility, for example), we can solve for it. The VIX does precisely this for the overall equity market. It is, however, intellectually spurious to assign cause and effect to these volatility surges, although the labels on our graph do The nearby graph shows the VIX for the past 15 years and precisely that. In the same way that Sherlock Holmes found reveals that the Christmas Eve spike in volatility, while rare, curious evidence in the dog that did not bark in “The Adventure is not unique. The index has risen above 35 on six separate of Silver Blaze,” there are plenty of dogs that are not barking occasions over this period, corresponding to pronounced mar- in this graph of market volatility. There are, for example, no ket developments, from the onset of the financial crisis, to the volatility spikes labeled “trade disputes” or “Brexit,” although downgrade of the U.S. debt rating, to the occasional elevation both developments pose potential threats to the economy and in fears about economic growth at home or abroad. financial markets. These “dogs that do not bark” should prompt us to exercise caution when assigning cause to market action.
Brown Brothers Harriman Quarterly Investment Journal 2 It is, in fact, a product of hindsight bias that there are labels on prices over the next few days, weeks and months. The good this graph at all. It is human nature to want our effects to have news is that once the system shifts it is in a much more resilient causes, and in retrospect it is easy to assign blame for spikes in state. Criticality may start rising again right away, but the reset market volatility. The reality is that market moves often have makes the system healthier for a period of time. more to say about the internal state of the market than about external influences. Let us return once again to history as both a guide to and justifi- cation of this analogy. The VIX has risen above 35 only 12 times Consider the following analogy. If we were to slowly build a pile since the creation of the index in 1990, including last Christmas of sand one grain at a time, a predictable shape would eventually Eve. As the nearby table illustrates, equity prices often remain emerge. At some point, one additional grain of sand, however, under pressure for a few weeks following the spike in volatility. would cause the whole pile to shift. We would stop and wonder One month out, the market remained in negative territory in why the pile shifted, and as tempting as it would be to blame half of our historical examples, for an average return of -0.7%. the last grain of sand that we dropped, the last grain was no Further out, however, returns have historically improved, so different from all the grains that had come before. In reality, that by a full year later eight out of 10 periods enjoyed positive the pile shifted because it was in a critical state in which it was and even double-digit rebounds. prone to overreact to external factors, even if that last factor was no different from what came before. Equity Market Responses to VIX Spikes > 35 Date +1 month +3 months +6 months +1 year 8/6/1990 -5.6% -7.9% 3.8% 15.6% 1/14/1991 17.5% 20.7% 21.5% 35.7% 10/30/1997 3.7% 7.6% 20.0% 20.0% 8/27/1998 -3.7% 9.9% 15.7% 27.3% 9/17/2001 0.6% 3.2% 6.3% -17.2% 7/15/2002 0.0% -8.3% 2.0% 10.9% 9/17/2008 -22.0% -24.4% -36.7% -9.4% 5/7/2010 -5.2% 0.1% 9.5% 21.3% 8/8/2011 0.2% 5.9% 13.7% 19.6% 8/24/2015 -1.4% 6.7% -1.3% 13.7% 2/5/2018 -2.0% -3.9% 4.2% ? 12/24/2018 10.1% ? ? ? Now consider the parallel to fourth quarter 2018. As easy as it is to blame the correction on trade disputes, higher interest Positive 6/12 7/11 9/11 8/10 rates, fears of an economic slowdown, a potential government Returns shutdown and so forth, none of these developments was new. Average -0.7% 0.9% 5.3% 13.7% Investors knew all these things back in September when the Source: Chicago Board Options Exchange and BBH Analysis. Data as of January 30, 2019. market was establishing new highs. Even the government shut- down that began in December and lasted into January was the Two exceptions to that generalization warrant closer attention. third shutdown in 2018. These developments are analogous to In 2001, the VIX spiked to 42 on the day that equity markets the grains of sand falling onto a sand pile that is in an increas- reopened following the truly unprecedented attacks of 9/11. ingly critical state. As we saw previously, the pile of sand that One year out, the market was down 17%, but for fundamental is the equity market had gone so long without shifting (recall reasons. Although it was not clear at the time, by September the absence of 2% trading days in 2017) that it was primed to 2001 the economy was slipping into recession for reasons unre- overrespond to external developments. lated to the attacks in New York, Washington and Shanksville, and the linkages with which we started this commentary held This analogy offers both bad and good news. The bad news true. Weaker economic growth translated into weaker earnings, is that it is difficult to the point of impossibility to accurately which in turn dragged down the equity market. The spike in gauge the critical state of a system as complex as a pile of sand volatility was correlative, but not causative. or financial market. There is simply no way to determine that the pile of sand is a certain number of grains away from shifting, and this makes it impossible to predict the movement of stock
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2008 offers a similar lesson. On September 15, 2008, Lehman Similarly, the primary driver of the income effect is the labor Brothers collapsed into bankruptcy, and the following day market. Lower unemployment means more jobs – and more the government cobbled together a bailout of AIG. The VIX, paychecks to spend. Psychology plays a crucial role here as well. which had been steadily rising as the financial crisis unfolded, A healthy labor market means more job security, which leads to spiked above 35 on September 17 and eventually reached a re- a greater willingness to spend money. Furthermore, rising wages cord peak of 80 a month later. This was the onset of the Great usually accompany an improving labor market, providing even Recession, the worst period of economic contraction since the more fuel for the personal spending fire. The state of these twin Great Depression. Once again, the fundamental linkages be- markets – housing and labor – tells us much about the current tween Main Street and Wall Street held, and a year later the and likely future state of personal consumption, and therefore equity market remained lower. the economy.
Some market observers are quick to conclude that recent vola- Pressures in the housing market are well documented. Rising tility is a harbinger of economic gloom to come. History tells us mortgage rates and new constraints on the deductibility of that a spike in volatility, such as we experienced in December, mortgage debt pose challenges to the housing market, but this may indeed indicate the onset of something worse, but only has yet to appear in prices. The homebuilding sector is slowing if the fundamentals warrant it. We turn our attention now to down for these two reasons, but if anything, this decline in new the economic fundamentals to determine whether last fall was construction supports the prices of existing homes in the longer merely another in a long line of corrections in this bull market run by not allowing supply to build too rapidly. or the beginning of something worse. There is scant evidence that housing prices are under pressure. The Economy in 2019 Nationwide, housing prices are up 4.2% year over year, and a study of major metropolitan areas shows that every geographic The primary driver of macroeconomic growth in the United region of the country is participating in this rise, albeit at different States is personal consumption. The spending decisions that 325 paces. Whereas we readily acknowledge that higher interest rates million Americans make daily comprise 68% of GDP. This is and changing tax rules may slow down the rise in home prices, not to deny the importance of business spending (17% of GDP), we have yet to see prices decline in any geographic market. government spending (16%) and net exports (-3%), but simply to observe that every other part of the economy ex-consump- tion adds up to 32%, and this 32% cannot possibly be robust The ousin Market enough to overcome weakness in personal consumption. It is 300 000s 20% no exaggeration to conclude that as goes the consumer, so goes 15% the economy. 250 Average Ho e Pri e s 10% 200 The Anatomy of the U.S. Economy 5%
150 0%
Housin ar et ealth e t -5% 100 ersonal Consu ption D -10%
a or ar et In ome e t 50 Year-over-Year C ange r s -15%
Sour e Nationa Asso iation o Rea tors an BBH Ana sis. Data as o Januar 30 2019. elevera in avin s 0 -20% 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
The labor market is similarly in good shape. As of December The nearby flowchart illustrates the role that various aspects 2018, the nation has added jobs for a record 99 consecutive of the economy play in translating personal consumption into months, bringing the unemployment rate down to 3.9%. The GDP. The most important store of wealth for most American last time the unemployment rate was this low, Lyndon Johnson households is a home, not a financial asset. The rise and fall occupied the Oval Office, and the Beatles’ “Hey Jude” topped in the value of homes drives the wealth effect, which is both a the Billboard charts. The unemployment rate for workers with real as well as a psychological dynamic. Even if a homeowner a college degree has dropped to 2.1%, indicating that 97.9% has no need or desire to sell her home, and no inclination to of the people in this country who have a college degree and take money out by remortgaging or opening a home equity line want a job have one. of credit, rising home prices make her feel and act wealthier.
Brown Brothers Harriman Quarterly Investment Journal 4 At present these dynamics are in good balance. There is enough improvement in the housing and labor markets to support personal consumption while at the same time allowing households to repair their balance sheets.”
Forward-looking measures indicate that this improvement will likely continue. As the nearby graph illustrates, the number of ouseho e t to isposa e Income 90 job openings has exceeded the available supply of labor for nine 160% inan ia risis consecutive months, indicating that the labor market should 80 140% 133.6% continue to improve as this mismatch of jobs and workers is 70 120% addressed. Furthermore, the fundamental laws of supply and 60 demand argue that wages should also continue rising. Average 100% 99.4% 50 as ras U.S. e t o ngra e hourly earnings were up 3.2% year over year in December, the 80% C inese gro t on erns 40 U.S. gro t fastest growth in a decade, and well ahead of consumer price on erns inflation of 1.9%. The linkages are clear: More people with 6300% more money (even adjusted for inflation) should translate into 4200% more spending and economic activity. 2100%
SourceSour e : Chica Stan ar go Board Options Poor s an Exchange BBH Ana sis. and BBH Analysis. DDataata a ass o o f JJanuar anuary 30 30 2019., 2019. 00% Supp y an eman in the a or Market 20109551 20061957 2007 19632008 19260909 21091705 20119181 20121987 2013 19932014 19290915 201056 20210711 20182017 2019
000s 18 000 From peak of 134% debt to disposable income in 2007, just 16 000 Avai a e Su o La or prior to the onset of the financial crisis, household debt levels 14 000 are now down to just below 100%. The difference between this 12 000 peak and the current level amounts to $5.3 trillion of forgone 10 000 spending, which explains why this economic cycle has been 8 000 so modest. The ratio of debt relative to household assets is
6 000 back to where it was in the early 1980s. In the long run, this is Jo O enings 4 000 good news: The restoration of household balance sheets means that the next economic cycle is not likely to be as deep and 2 000 Sour e Bureau o La or Statisti s an BBH Ana sis. Data as o Januar 30 2019. protracted as the last one. In the short run, however, delever- 0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 aging represents competing demand for every marginal dollar of household wealth or income. There is something different in this economic cycle. For the first At present these dynamics are in good balance. There is enough time in decades, or even generations, American households are improvement in the housing and labor markets to support per- restoring the health of their balance sheets by deleveraging and sonal consumption while at the same time allowing households boosting their savings. This may appear to be a counterintuitive to repair their balance sheets. Tax cuts boosted personal incomes claim, as reports show that household debt is at an all-time high. in 2018, which fed through into better GDP growth. Our ex- Whereas it is true that household debt has risen close to 1% per pectation is that growth will revert to more modest levels in annum for the past decade, at the same time household income 2019 as the tailwinds of tax cuts subside. The economic story has risen by 3.5%, and household assets have grown by 4.3%. of 2019 is moderation. Therefore, debt relative to income or assets has declined, as the nearby graph indicates.
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Financial Markets in 2019 to do so at a measured pace. Nevertheless, at present the fu- tures market seems skeptical that rates will rise at all in 2019, Recalling the linkage from Main Street to Wall Street with which assigning the highest probability to a scenario in which the we opened this commentary, moderate economic activity should fed funds rate remains at the current level of 2.25% through support equity market fundamentals this year. Here, too, we ex- the year. The January Fed meeting reinforced this expectation, pect 2019 to be a year of moderation, as the benefit of corporate as the statement following the decision to leave interest rates tax cuts is fully included in year-over-year comparisons. We are unchanged acknowledged “muted inflation pressures,” allow- just beginning to get a better picture on how corporate America ing the committee to “be patient as it determines what future ended the year, but it seems likely that earnings growth for the adjustments to the target range” are appropriate. The path and full 2018 calendar year will be around 25% when all companies pace of monetary policy is a development worth monitoring have reported their fourth quarters. This is a remarkable pace closely as the year unfolds. of profit growth for a mature economic cycle, with tax cuts accounting for about half of the improvement. The municipal bond market has offered several fleeting entry points over the past few years, although at present we find muni A silver lining in the otherwise dark cloud of last year’s correc- yields broadly unattractive. Over the course of last fall, the tion is that market valuations are back down to more reasonable benchmark 10-year municipal bond yield fell from 2.80% to levels. The combination of a 25% rise in earnings and a 7% drop the current level of 2.25%, offering little real return at present. in the level of the index brought trailing PE ratios down from As and when rates rise to levels that offer better protection 22x at the beginning of 2018 to a current level of 17x. This is against inflation – even at modest levels – we will likely increase by no means cheap in an historical context but much closer to our clients’ exposure to traditional tax-exempt fixed income. the long-run average of 15.6x. If earnings growth moderates back down to a more sustainable level of 8% to 10% in 2019, as we anticipate, the implied forward PE ratio is right in line 1 ear Municipa on ie s 90 with the long-run average. This brings to mind once again the 160% 4.0% inan ia risis analogy of a pile of sand that is in much more robust shape 80 140% 133.6% 3.5% once the shift takes place. 70
31.20%0% 60 100% 99.4% S 5 Trai in E Ratio 25.50% as ras U.S. e t o ngra e 3900 80% C inese gro t on erns 160% 2.0% U.S. gro t 40 on erns inan ia risis 80 2 stan ar eviations 16.50%% 21540% 133.6% 25.7 30 70 124.00%% 120% 1 stan ar eviation 2600 20.7 01.50% 100% 99.4% 20% 50 Average 16.2 Sour e B oo erg an BBH Ana sis. Data as o Januar 30 2019. as ras 0 SoSuorucer:c eC: hFiecdaegroa lB Roaesredr Optionsve and BExchangeBH Ana andlysi sBBH. Analysis. D D a at a t a a as s o o f f J aJannuuaaryry3 300, ,2 2001919. . 15 U.S. e t o ngra e 15.6 0.00%% 80% C inese gro t on erns U.S. gro t 220100905591 2006129051702007 196232001018 192609029012 21091705 201230119181 202102114987 2013210919532014 192209019165 2010256017 20210711201280182017 20210919 40 on erns
60% 10.6 1300 - 1 stan ar eviation 2400% What Could Go Wrong? 5.6 5 - 2 stan ar eviations 1200% The preceding paragraphs lay out a decent fundamental ex- SoSour e urce: C hStan ar icago B o a Poor srd Options an BBH Exchange Ana sis. and BBH Analysis. DataDa asta o as Januar of Janu 30 ar y2019. 30, 2019. 000% Source: Federal Reserve and BBH Analysis. D a t a a s o f J anuary 30, 2019. pectation for 2019, albeit one that could still be plagued with 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 19416951 11995574 19613962 1969 1970 1975 19718981 11998867 19199394 19992002 2005 20102011 20210817 volatility. As the year unfolds, we will closely watch several developments that could threaten to derail this otherwise be- The proverbial grains of sand will continue to fall in 2019, and nign outlook. we cannot rule out the possibility of more volatility ahead. As active investors, we welcome this, at least in measure. It is not First, there is a disconnect between inflation expectations and pleasant when external developments whipsaw markets, but economic reality. Perhaps because inflation has been so quiescent it is precisely the difference between price and value that we for so long, investors are placing a low probability on its return, intend to exploit when allocating capital. Volatility creates this despite a healthy labor market and solid economic fundamen- disconnect, and this disconnect creates opportunity. tals. Inflation expectations embedded in the 10-year government Treasury inflation-protected security (TIPS) have fallen below Steady improvement in economic and corporate activity should 1.8%, and the Federal Reserve’s own expectations for core in- allow the Federal Reserve to continue raising interest rates, flation rise only to about 2.0% over the next few years. and the absence of inflationary pressure should also allow it
Brown Brothers Harriman Quarterly Investment Journal 6 market has interpreted Chairman Jerome Powell’s comments To add to the uncertainty, the ceiling following recent meetings to indicate a pause in interest rate increases as the Fed determines the effect of last year’s four rate on issuance of federal debt – hikes. The futures market currently indicates close to a 90% suspended as part of the 2018 budget probability that the Federal Reserve does not raise rates at all throughout 2019 and a growing (but small) probability that agreement – is scheduled to spring economic conditions actually warrant a rate cut in the fourth quarter. back into existence on March 2, 2019, We admittedly expect economic activity to moderate in 2019, likely at the prevailing level of but primarily as a result of annualizing the benefit of tax cuts last year. The current fed funds rate target of 2.25% to 2.50% outstanding debt on that day. The implies that the real (that is, inflation-adjusted) rate is barely positive. We believe that the Fed could raise rates in 2019, debt ceiling has become a political particularly if wage growth continues to accelerate. Whether or not this surprises the market remains to be seen. We note that football before, and either party this year the Fed intends to hold a press conference following every meeting, and this enhanced frequency of communication (or both) might resort to it again to may help to mitigate the risk of a surprise. further a political agenda.” A third risk is based not in Main Street or Wall Street, but in our nation’s capital. Although we have historically concluded that developments in Washington are more noise than substance, we acknowledge that escalating political dysfunction could over- 1 ear reake en Sprea whelm sound economic fundamentals. This is a change. History shows that the market and economy historically ignore political 3.00% squabbles, such as the one over funding border security that 2.50% partially closed the government for 35 days in December and January. Indeed, the S&P 500 rose close to 8% over the course 2.00% of the recent shutdown. 1.78% 1.50% The current environment in Washington, however, demon- 1.00% strates that both parties are willing to weaponize the normal functioning of government in pursuit of political ends, with 0.50% unpredictable implications. There were two government shut- 0.00% downs during the eight years of the Clinton administration and
Sour e B oo erg an BBH Ana sis. Data as o Januar 30 2019. only one in Obama’s tenure in the White House. George H. W. -0.50% 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Bush presided over just one government closure, and his son George W. Bush saw none. There have been three shutdowns in the Trump administration, and the current ceasefire is scheduled This seems incompatible with an environment in which wages to expire in February. are growing at 3.2% (as of December) and may accelerate as the labor market continues to tighten. In the nearer term, if tariffs To add to the uncertainty, the ceiling on issuance of federal debt on Chinese imports remain or even increase, import price pres- – suspended as part of the 2018 budget agreement – is scheduled sure may feed through into consumer inflation as well. We are to spring back into existence on March 2, 2019, likely at the reminded of the old adage that, whereas the most anticipated prevailing level of outstanding debt on that day. The debt ceiling risk is least dangerous, the least anticipated risk is the most has become a political football before, and either party (or both) dangerous. Inflation seems to be a more dangerous risk than might resort to it again to further a political agenda. In previous the market is acknowledging at present.1 episodes of debt ceiling crises, investors have worried that the U.S. might technically default on shorter-term Treasury bills A second and related disconnect is that between economic reality that are legally prevented from being rolled over. Whereas we and expectations for the path and pace of monetary policy. The
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assign a low probability to the U.S. defaulting on its debt, even Economic activity is slowing both in China and Europe. We temporarily and technically, we must concede the possibility that believe that the Chinese slowdown is a story of secular trans- an economic accident arises from the climate in Washington. formation rather than cyclical weakness. Simply put, as the Chinese economy grows and matures, it will no longer be able to e era e t an the e t ei in support the historical growth rates associated with an emerging 90 tri ions economy. This is a mark of success, not failure. China is already 21560% 4.0% inan ia risis 80 the second largest economy on the planet, and large economies 140% 133.6% 3.5% do not sustainably grow at high rates. 2700 31.20%0% 60 De t Cei ing Europe is another story. Economic growth in the eurozone has 100% 99.4% 125.550% as ras decelerated for four consecutive quarters, to an anemic pace U.S. e t o ngra e 80% C inese gro t on erns 2.0% U.S. gro t of 1.6% in the third quarter of last year. Uncertainty about 40 on erns 10 the economic and trade implications of the United Kingdom’s 136.500%% intended exit from the European Union weigh on economic 124.00%% Outstan ing e era De t 5 activity, and this uncertainty is likely to get worse before it gets 012.500%% better. We will listen carefully for how companies report their
SoSSouourucrcere:c: e CB: hlFoieocdmaegbroear lBg Roaensrde rBOptionsvBe Ha nAdna BExchangelyBsiHs. A Sour e n a andl y s i s BBH .U.S. Treasur Analysis. an BBH Ana sis. D D a at a t a a as Datas Do oa f tf Ja aJ asansnu o ouaf arJanuar Jyrayn3 u30a0, r,2y 20 30 301091, 2019.9.2.019. 00.00%% non-U.S. earnings for evidence that weaker growth abroad is 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 1972103905911976 129051179079 119962830211 1918965920129818975192901319811994 20114998977 220100910953 2003192091962006 202025000197 201112201820210517 201198 translating into slower corporate profit growth.
Although this commentary focuses on developments here in the Conclusions United States, we also acknowledge that circumstances abroad The challenge confronting investors is to make a distinction may affect economic and market conditions here at home. The between those developments that threaten to impair sentiment, real risk lies not in headlines related to Brexit or trade disputes and therefore price, and those developments that threaten to with China: Total net trade with every U.S. trading partner impair fundamentals, and therefore value. We have experienced amounts to only -3% of GDP (negative because of the aggregate plenty of damage to sentiment, leading to the price volatility of trade deficit). The far more important translation mechanism the previous quarter, exacerbated in turn by a market primed is through corporate revenues and profits. For the full 2017 to overreact. Despite the litany of risks outlined in this com- calendar year, companies in the S&P 500 generated 44% of mentary, we conclude that economic and market fundamentals their total revenues outside the United States. The geographic remain sound while acknowledging that moderation is likely to breakdown is not as precise as we would like, as many compa- be the storyline as 2019 unfolds. nies do not report granular exposures, but the nearby pie chart illustrates the reliance of U.S. companies on Asia and Europe Risks to sentiment abound, and volatility will likely return to in particular. markets throughout the year. Whereas patience and a disci- plined focus on value are key ingredients of investment success eo raphica Source of S 5 Re enues 2 17 throughout a cycle, they are particularly important in an envi- South America, ronment of heightened uncertainty and volatility. We seek to North America, 2.79% 1.54% Australia, 0.07% Africa, 3.90% allocate capital into assets whose value will remain healthy in periods of economic and market stress, even if the price of those assets does not reflect that health on any given day. Patience Europe, 8.14% will become increasingly valuable when it is in short supply.
Past performance does not guarantee future results. Asia, 8.26% 1 United States, 56.37% For more on our views around inflation and the threat it poses for investors, read our third quarter 2017 InvestorView article, “Everything You Ever Want- Unallocated Foreign, 18.93% ed to Know About Inflation (But Were Afraid to Ask).”
Sour e U.S. Treasur an BBH Ana sis. Data as o Januar 30 2019.
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