The fourth quarter will provide critical insight into the near-term direction of the US-China trade conflict as well as into whether the Fed will maintain the narrative of a mid-cycle monetary policy adjustment or switch to acknowledging an outright easing cycle. We have become increasingly concerned that the impact of trade tensions is beginning to filter through not just to markets, but also to the broader US economy. Industrial and trade-exposed sectors have been suffering for several quarters, as have the major economies most reliant on these sectors. However, household consumption accounts for roughly 70% of US GDP, and US households remain in a relatively good spot, implying that they can sustain economic growth just as they did during global economic weakness in 2015 and 2016 (see Exhibit).

Exhibit: Household Consumption (~70% of US GDP) Remains Strong

Real Personal Consumption Expenditure

As of August 2019
Source: Bureau of Economic Analysis, Haver Analytics

Nonetheless, weak capex trends suggest that businesses have become more cautious in their expectations and may be inclined to wait and see what happens with policy before putting capital to work. Similarly, jobs growth has slowed, although it is unclear whether this is due to the declining supply of available labor or employers pulling back on hiring in the face of uncertainty. Most importantly, while retail sales still look good and housing activity has rebounded, there are signs that consumer confidence is softening and that households are becoming more concerned about the economic outlook and tariffs.

In the quarter ahead, we will remain focused on the US consumer, looking for evidence of weaker sentiment and slower activity. We also will be monitoring several key global risks: the Japanese consumption tax hike effects, a number of milestones on trade, Brexit, another potential US government shutdown on 21 November, and rising tensions in the Middle East.

As we have emphasized in past quarters, we believe the best strategy for US equity investors against this mixed backdrop—slowing growth globally, supportive central banks, very low interest rates, and equity market resilience amid trade tensions—is to remain overweight equities, but concentrate capital in companies with high sustainable returns on capital that trade at attractive valuations. While equities appear expensive relative to history, we view them as cheap relative to fixed income and believe security selection is critical to avoid overpaying for perceived safety.

The preceding is an excerpt our Outlook on the United States. Read the full paper.

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Information and opinions are as of 3 October 2019.

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