Looking at the beginning and ending levels for equities and fixed income during the third quarter, one might erroneously conclude that it was another summer snoozefest. However, there was volatility during the quarter as the equity markets shrugged off a sloppy August awash in second quarter earnings disappointments and staged a solid comeback rally through September. The S&P 500 Index finished the quarter up 1.70%, the Nasdaq 100 Index increased 1.29% and the ICE BAML U.S. High Yield Index rose 1.22%.

Beneath the surface there were seismic shifts in market leadership that suggest investors are becoming increasingly cautious in their positioning. This is corroborated by the fall in the 10-Year U.S. Treasury yield from 2.00% at the end of the second quarter to 1.68% at the end of the third, as investors sought the safety of government bonds. We think a little skepticism in the investment community and some rotation out of expensive, high-growth tech stocks into more defensive names is the sign of a rational market, which we prefer to a market that overpays for pie-in-the-sky growth expectations.

As we examine the factors that encourage us and weigh them against those which concern us, we continue to be cautiously optimistic about the economy and the investment climate. While we haven’t seen too many fat pitches in this low rate environment, we believe there are still plenty of opportunities to earn a solid return above cash without taking imprudent risks as we wait for greener pastures.

Since we tend to be cautious by nature, let’s first examine some of the topics and recent events that concern us – namely, the hegemonic battle between the U.S. and China, the effectiveness, or lack thereof, of central bank monetary policy in an unnaturally low global interest rate environment and the recent turbulence in the repo market.

Much of what has been written in the press about the struggle between the U.S. and China refers to it as merely a “trade war.” That’s akin to calling the Super Bowl just another football game. It is in fact an all-out battle for global leadership on many fronts — technological, social, religious, ideological, political and economic. Trade is just the most visible (for now) battle in a much larger struggle.

The U.S. has enjoyed the benefit of having the largest and arguably the most successful economy the modern world has ever seen, which, along with our role as the world’s policeman, has allowed us to remain in the global leadership seat for the better part of a century. The globalization of the world economy, which has been accelerating for the past 30 years, set us down a path for this conflict. The overzealousness of both foreign countries and multinational companies to court China as a trading partner, given their large and upwardly mobile population, was bound to result in lopsided deals favoring China.