Many increasingly fear the global economic recovery is in severe peril because overused economic policies have become futile. Bloated central bank balance sheets, large fiscal budgetary fiascos, and the unprecedented global phenomenon of widespread negative bond yields leaves an impression that economic help is spent!
The stock market is re-testing its August 5th collapse low, the U.S. 10-year bond yield is nearing its lows of this recovery, yet another yield curve inversion (tens vs. twos) was breached this week, silence from the Federal Reserve, negative yielding global debt now totaling more than $15 trillion, an escalating riot in Hong Kong, and trade-war negotiations hanging by a thread as ongoing communications are now only by phone! Whew, it’s tough being a bull. Maybe foolhardy?
Adding to current anxieties are the growing fears that businesses may be curtailing spending plans. Real nonresidential investment spending declined in the second quarter for the first time since early 2016. However, this decline was due entirely to ‘old-era investment spending’ while ‘new-era spending’ remains healthy.
This is why financial market prognostications are so difficult and why some believe fruitless! Currently, two recession indicators – both with equally impressive accurate historical prowess – are giving entirely contradictory signals? As shown by the accompanying charts, the yield curve has inverted while fiscal stimulus has been expanding. At least since 1965, this has ‘never’ happened.
Despite the current drama, the stock market will not likely be sustainably driven by the Federal Reserve, ongoing trade negotiations, or by presidential politics. Although these spectacles will continue to bounce the market around, ultimately, its direction will most likely be tied to corporate earnings.
Despite a widespread impression that business confidence is declining under the weight of ongoing global uncertainties, it was reported yesterday that, after being flat for almost a year, new orders for nondefense ex-air capital goods (core business capital goods spending) rose to a new recovery high in June.
Little is expected from the current earnings season. At best, corporate profits may eke out a small gain compared to last year’s second quarter. Moreover, with Trump’s trade war still threatening to worsen, the yield curve still inverted, and because the U.S. economy is now in the longest expansion in its history, many are understandably worried that earnings growth may remain challenging.
As shown in Chart 1, since 2015, the trade-weighted U.S. Dollar index has generally ranged between 90 and 100. Its recent stability, at a level much higher than it was during the first half of this economic recovery, has played an important role in shaping the economic and financial-market landscape.
There is still plenty to worry about. The never-ending trade war enters yet another round of negotiations, geopolitical risks simmer, many economic reports (both in the U.S. and around the globe) remain weak, the size of negative-yield debt is becoming nearly as large as U.S. GDP, the U.S. stock market continues to exhibit a worrisome “triple-top” pattern, small cap stocks continue to trail, the yield curve is still inverted and, because of a “strong” jobs report on Friday, there is now doubt about whether the Fed will cut interest rates later this month.
Like today, the Federal Reserve usually sucks all the oxygen out of the national economic-policy conversation. And, why not? It is comprised of a small elite group who hold conferences in exotic locations (Jackson Hole), have regular strategy meetings culminating in ‘must-see’ press conferences, make dot-plots sound interesting, and, between meetings, members regularly spout-off contradictory opinions.
This week the Federal Reserve delivered the requisite preamble signaling an inevitable cut in the Fed funds rate. Following that, the 10-year Treasury yield declined below 2%, financial markets now point to a 100% probability of a rate reduction, and the old adage ‘Don’t Fight the Fed’ has been ringing in investors’ ears.
A survey asking equity investors whether the stock market does best with a strong or weak U.S. dollar would likely yield a variety of contradicting opinions—and they would all be correct! Like many couples, the stock/dollar relationship is complicated. Sometimes they get along blissfully, other times they separate because they find they rarely agree and, often, they simply seem indifferent to each other. They are an odd couple!
Despite the current trade war with China, the U.S. economy has taken on an air of ‘Goldilocks’ since the December stock market swoon. Real economic growth has slowed, and both inflation and interest rates have moderated. The pace of growth is no longer too hot—as it was last year—nor has it yet become too cold—as most feared earlier this year.
After the December stock market swoon, amidst escalating recession fears, the Federal Reserve hit the pause button on interest rate hikes. Investors, though, had a déjà vu moment, sensing the 2018 experience as reminiscent of a few years earlier and, considering the aftermath of the prior occurrence turned out to be profitable, investors in 2019 opted to hit the replay button!
An aging economic expansion can be hazardous for investors. It tends to develop vulnerabilities (e.g., indebtedness, a lack of savings, over-indulgences, etc.) which threaten a premature ending. Often, old recoveries develop a capacity shortage leading to worsening inflation, interest rate pressures, and restrictive economic policies.
Investors have struggled this year with the relationship between stocks and bonds. The stock market seems very optimistic about the future, whereas bonds appear much more reserved, if not frightened, by the outlook. Should investors be concerned by the seeming contentiousness between stocks and bonds?
This morning’s U.S. GDP report should help calm fears about a pending recession and perhaps set the stage for a surprising acceleration in economic growth? Fears of recession have caused the Federal Reserve to pause its tightening campaign, slightly boost the pace of money supply growth, and significantly lower long-term yields. Improved monetary accommodation definitely raises future economic growth prospects.
Compared to post-war norms, the contemporary economic expansion has been odd in many ways. Persistent sub-par economic growth, a lack of normal lending and borrowing activities, declining labor-force participation rates, a stubbornly high underemployment rate, an inflation no-show, negative yields, and bizarre economic policies (e.g., TARP, cash for clunkers, stress tests, and quantitative easing).
U.S. profit margins have widened significantly in the last couple decades. Total U.S. corporate profits as a percent of GDP averaged only about 8% in the 20 years leading up to 2000, but has since risen by almost 30%, averaging 10.5%. Similarly, the overall profit margin among S&P 500 companies has increased steadily in this recovery to record highs!
The U.S. yield curve has inverted (at least the 10-year Treasury yield to either the 3-month T-bill or the Fed funds rate) and captured the full attention of investors. Rightly so, since a yield curve inversion has historically been an excellent indicator of a pending recession. However, a condition that has always existed in the post-war era when the yield curve has inverted is absent today.
Stocks do best in times of general price stability. In the post-war era, the stock market has provided investors with significantly higher returns and lower risk whenever the annual rate of consumer price inflation has been between 1% and 3%. However, when outside this “Sweet Spot”—when the porridge is either too hot or too cold—investment results are far less hospitable.
The stock and commodity markets have been messaging confidence in the future of this economic recovery since the December stock swoon. The S&P 500 has surged by about 10% so far this year on strong breadth led by economically-sensitive small cap stocks and cyclical sectors, while traditional defensive equities have lagged.
Arguably, the biggest risk facing the stock market is a recession. Currently, traditional recession gauges are mostly comforting and a key indicator—balance sheet health—is remarkably strong. Often, recessions occur when financial health deteriorates, limiting household or business capabilities and lowering confidence.
Economic growth in the contemporary expansion has been perpetually weaker than any in the post-war era. Many explanations have been offered for why the U.S. is stuck in low gear, including aging demographics, overextended balance sheets, overused and increasingly ineffective economic policies, and a tech-boom-induced world awash with excess capacity.
Just some noodling over an array of issues including:
- What private sector confidence currently suggests about the stock-bond allocation tilt?
- Is the fuel for Populism fading?
- Will winning the trade war cause U.S. stocks to lose?
- How have stocks performed once the unemployment rate bottoms?
- What does a 2019 U.S. economic slowdown imply for the 2020 election?
- A nice revaluation refresh for stocks!
Emerging Markets (EM) are not generally considered defensive investments and, therefore, investors do not often turn toward these economically-sensitive stocks near the end of a bull market cycle. However, as Chart 1 highlights, if the current economic expansion/bull market is in its late innings, perhaps you should consider “Emerging for the Finish.”
During the December carnage many Bulls were killed on the battlefield and others badly wounded. This year, although the skirmish has quieted, most remain on edge. However, investors may just now be jumping out of their foxholes because the Cavalry has recently been sighted coming over the hill with bugles blaring!