We normally don’t make too much out of indexes that are hovering around round numbers, especially a random number like 500, but for global equities this may be meaningful. The MSCI All Country World Index is a key benchmark for global portfolio managers and over the course of the past year, the 500 level has served as both a level of support and more recently resistance. The index just pierced the 500 mark February 18th and that could provide a psychological lift for investors. The key will be if market leadership can broaden beyond the US stock market and carry the index even higher. While valuations in the US are attractive, earnings growth is slowing. The rest of the developed world does offer value, although growth is still anemic — value alone may ultimately attract investor interest.
There has been a lot focus over the years on economic conditions in southern Europe and in particular Italy, which is potentially headed into a painful debt crisis. We share these concerns, but Europe’s problems reach beyond the peripheral countries. German quarterly GDP growth has lagged the region for the past two quarters, and the best one could say is that activity in this key economic engine is getting less worse. The German Federal Statistics Office reports flat growth for the fourth quarter versus a decline in Q3, thus narrowly avoiding a recession. Germany is the world’s third-largest exporter and it is undoubtedly facing headwinds associated with slowing global economic growth, notably in China, and uncertainty related to the US – China trade negotiations as well as the outcome of Brexit. Germany is the largest economy in the Eurozone and this growth stall may prompt Brussels to adopt a more pro-growth policy stance. That would be welcomed news, particularly to the Italians. Stay tuned.
The MSCI USA Cyclical Sectors – Defensive Sectors Index measures the performance differential of sectors such as Technology and Consumer Discretionary versus traditional defensive sectors such as Utilities, Telecommunications and Consumer Staples. After suffering one of the worst corrections since 2011, the index appears to have begun to recover. It is no secret that risk assets have rallied strongly so far this year, but if the rebound in this index can be sustained, broader gains in the US equity market and other riskier asset should continue.
The index corrections that we experienced earlier in the decade were related to concerns about global growth. In the 2010-2013 period, the volatility centered mainly on the viability of the Eurozone and economic stress in Portugal, Ireland, Italy, Greece and Spain (PIIGS). Now Italy appears headed towards recession while Germany and France are also facing headwinds. The beginning of 2016 also marked a period of heightened index volatility due to Chinese growth concerns. Similar issues in these key segments of the global economy persist, but the US Federal Reserve is now perceived to be much more accommodative after setting a more hawkish and restrictive tone in the Fall of 2018.
The Bloomberg US Financial Conditions Index measures the
overall levels of stress in the US capital markets in order to evaluate the
availability and cost of credit. A
positive reading suggests that financial conditions are benign whereas a
negative reading indicates a more restrictive financial environment. This week’s
chart shows this indicator (the thin line plotted on the right-hand vertical
axis) alongside the S&P 500 (the thick line plotted on the left-hand
When the financial conditions index worsens or
turn negative, US stock prices tend to perform poorly. The good news is that financial conditions
have improved and are now positive according to this index which should be
supportive of US equities and other risk assets going forward if this index can maintain positive
momentum. We stress that positive
financial conditions can be short lived, as shown below, causing equities to
struggle. For the present, positive financial
trends, attractive valuations and positive albeit slowing earnings growth
should buoy US stock prices and other risk asset classes.
Markets have responded negatively to Monday’s release of a fourth quarter GDP growth rate of 6.4% by the Chinese government. The reality is that growth in China has been moderating since the Great Recession, which should not be unexpected since China is now the world’s second largest economy next to the US. What has compounded matters is that the rest of the developed world, particularly the Eurozone, the UK and the US, also is showing signs of moderating economic activity.
There is also considerable speculation that the actual growth rate is lower than official government figures suggest. The chart below depicts the official Chinese government figures and the Li Keqiang Index, an economic proxy index calculated by Bloomberg Economics, which combines growth rates in outstanding bank loans, electricity production, and rail freight volume. The latter index is regarded by some as more timely as well as more accurate, and that may be true, but both indices are trending downward. It is important to note that the Li Keqiang measure is in nominal terms and after adjusting for inflation, currently expected to be approximately 1.9%, in line with or even below the official GDP release. Both indices are decelerating and it remains a viable consideration that economic growth could be even lower.
As we have stated in the past, we consider days like Dr. Martin Luther King, Jr. day to be opportunities to speak less and listen more. Dr. King helped us all to better understand the value to society and to every individual in justice, inclusivity, respectfulness, shared dignity, and equality. These are messages and ideals that should ring throughout the year and not just on a single day. These are messages and ideals that should inform how we live, how we govern, and how we conduct business.
Thank you to Dr. King, and to his compatriots and successors, for words and deeds by which to live and thrive.
Benign Inflationary Measures Give Central Banks Room to Maneuver
Global stock and credit markets have begun to
regain lost ground after dovish comments from US Federal Reserve Chairman
Powell and his predecessors Janet Yellen and Ben Bernanke. Powell remarked that inflationary pressures
are not evident and market participants interpreted that as a sign of less urgency
for the Fed to continue to raise policy rates.
Inflationary readings are also declining in the Eurozone and Japan, bringing
inflation in all three key regions below their stated 2.0% target (the red line
on the chart). With the prospect of
imminent and continued interest rate hikes pushed further out in the year if at
all, the environment for risk assets should remain supportive. Yet, how the current US Government shut down,
now the longest in history, unfolds remains a major concern.
When the market is in free fall, the question we always ask before
being willing to assume more risk is “What will put in the bottom?” We have found through our years of analysis
and portfolio decisionmaking that the bottom usually arrives when a significant
gesture from outside the market changes the direction of sentiment. The severe
market correction stemming from the financial crisis a decade ago effectively
stopped in March of 2009 when Treasury Secretary Geithner gave form and
substance to the ideas put forth in the Emergency Economic Stabilization Act of
2008 (the Troubled Asset Relief Program, TARP). Europe stopped bleeding in late
July of 2012 when Mario Draghi, President of the European Central Bank, said in
his comments to the Global Investment Conference in London “…the ECB is ready
to do whatever it takes to preserve the Euro.”
20 Years of the Euro. As we head into 2019, the Euro marked its twentieth anniversary. In the years leading up to the launch of the single European currency there was a tremendous amount of optimism and pride on the Continent based on the potential advantages a unified Europe offered — a population, economy and market that could rival and surpass the United States. While those advantages are still true, the original fiscal requirements of the Maastricht Treaty, which harmonized national budget and debt ratios and allowed for the creation of the Euro, are now the root cause of currency and capital market volatility. Those fiscal constraints have become burdensome for the peripheral European nations that historically have had less fiscal discipline than northern countries. Over the past decade in particular, there have been a series of Euro-related crises that, in our opinion, will persist until Brussels relaxes these constraints. Unfortunately, that would likely only provide temporary relief to the long-term structural issues that persist.
Today’s announcement of the US Federal Reserve’s decision to increase policy rates by 25 basis points wasmet with a violent market reaction. Up until the announcement at 2 pm EST, major indexes in the US had solid gains. However, in the hour that followed, the market shed all gains and turned markedly negative. The intraday price decline in the S&P 500 — highlighted on the chart below — surpassed 3.7% which is nearly double the intraday price moves we highlighted in last week’s chart. What concerns us is that Chairman Powell’s dovish comments that the Fed now expects to raise rates twice next year, rather than three times as previously communicated, should have provided some relief. That clearly did not happen. Even with supportive economic activity, strong corporate fundamentals and attractive valuation levels, the US stock markets remain fragile.