Published September 27, 2019
Bond manager PIMCO recently offered their mid-year outlook for the global economy and markets. Their conclusions are:
“In a nutshell, we see a global economy about to enter a low-growth “window of weakness,” which we expect to persist going into 2020 with heightened uncertainty about whether it is a window to recovery or recession. During this window, we think it prudent to focus on capital preservation, to be relatively light in taking top-down macro risk in portfolios, to be cautious on corporate credit and equities, to wait for more clarity, and to take advantage of opportunities as they present themselves.
In our baseline scenario, we expect global GDP growth to slow further over the next several quarters as ongoing trade tensions and heightened political uncertainty in multiple jurisdictions continue to act as a drag on global trade, manufacturing activity, and business investment.
While labor markets have remained firm and consumer spending relatively solid in most advanced economies, we see the slump in global trade and manufacturing increasingly affecting other economic sectors via sagging corporate profits, reduced hiring, and a pullback in business investment. We expect U.S. GDP growth to slow to a meager 1% or so in the first half of 2020, down significantly from 3% in the first quarter and 2% in the second quarter of 2019. This would further corroborate our thesis that U.S. economic growth will be “synching lower” toward the rest of the world over the course of this year.
As a consequence, we see the global and the U.S. economy entering a low-growth window of weakness during which they are more vulnerable than usual to adverse shocks, with heightened uncertainty about whether it is a window to recovery or recession. While a recession is not our base case, it doesn’t take much to tip over an economy that is moving along at stall speed.”
Contrasting that cautious high-level view of the economy are the recent readings of the Citibank Economic Surprise Index. The Citibank Economic Surprise index compares the performance of economic data with economist projections. When projections grow overly pessimistic, it becomes easier for the data to outperform. That has happened recently as the surprise index has surged upward after a stretch of underwhelming data.
This index does not correlate well with stock market performance – note the sharp swings in 2017 while the stock market did nothing but move higher that year. Nevertheless, the index can provide a backdrop and explanation for some market behavior. The stock market has traded flat for months now, in a range, as economic data disappointed (trending down in the chart above) with global trade concerns rising. Now, with some economic data beating the pessimistic projections will stocks summon the ability to break to new highs? The upcoming earnings season will be an opportunity for investors to hear if the surprisingly not-bad economic data can translate into better-than-expected results for corporations. The other outcome is that corporations begin hinting at the scenario painted by PIMCO of increasing uncertainty tilting toward a weak outlook.
Most of the time, stock markets are wrestling with this type of cloudy information. The clouds then break and investors find a narrative that the mostly all agree on, for awhile. It is during those times that trends are strong and the opportunity for profits rich.”
Stocks were whipsawed by competing narratives on the success of trade talks with China this week. However, the week kicked off with the worst economic reports out of Germany in a decade. The reports kept stocks from making any progress as trading opened the week Monday with a flat result. Stocks tumbled -0.8% Tuesday as consumer confidence fell during the month of September while President Trump’s speech before the United Nations tossed a bit of cold water on optimism for a near-term trade deal with China. Wednesday morning, President Trump flipped the script, offering a more constructive outlook on the China trade talks sending stocks into recovery mode, rising +0.6%. A report suggesting that the U.S. will reinstate a ban on sales to Chinese telecom giant Huawei took the wind out of stocks Thursday, offsetting a strong earnings showing from consumer apparel maker Nike (NKE). The S&P 500 slipped -0.2%. A report suggesting that the Trump Administration is considering a limit on investments in China, including perhaps the de-listing of some Chinese companies from U.S. stock exchanges kept investors in a cautious mode Friday. Semiconductor firm Micron (MU) delivered cautious guidance during their earnings report Thursday night to exacerbate the caution surrounding firms with exposure to sales in China. Stocks dipped -0.5% Friday with the tech-heavy Nasdaq, more sensitive to the back-and-forth of China trade issues, sliding more than -1%. Further unnerving investors was the week’s announcement of impeachment proceedings against President Trump, though many reports acknowledged prior impeachment hearings have had little clear effect on markets.
The S&P 500 (SPY) closed the week with a loss of -0.97% as stocks spent a second week unable to clear the 3000 level. The Nasdaq 100 (QQQ) tumbled -1.78%, while small-cap stocks (IWM) fell -2.41%. Of some interest, the interest-rate sensitive sectors in the stock market – e.g. consumer staples, real estate, utilities – posted gains for the week as rates headed back downward after surging higher two weeks ago.
Warm wishes and until next week.