After the conclusion of US Federal Reserve’s scheduled meeting, Chairman Jerome Powell said that the Fed has reduced their planned Fed Funds rate increases to zero for the year by a unanimous 10-0 vote. Additionally, he announced that they would begin slowing the pace of balance sheet contraction beginning in June from $30 billion to $15 billion per month and end the planned shrinkage by September. These developments were received favorably by stock and bond markets because it signals that accommodative monetary policy will be supportive of asset prices. Investors have been concerned over the past several months that the Fed had adopted an overly restrictive monetary stance while economic conditions in the US were exhibiting signs of softening which could lead to recession. This week’s chart comes to us from the Bloomberg Economics team and shows the relationship between real US GDP growth and the real Fed Funds rate along with recessions going back nearly 50 years. The point the team makes is that, historically, the economy has yet to head into a recession with the real Fed Funds rate at current levels, and it is not until this key rate exceeds real GDP growth that a recession follows. Those occurrences are highlighted in the circles on the chart and do appear to be an early warning of recessions. We may have a fair amount of time before seeing those conditions develop.
Since the S&P 500 bottomed on March 9, 2009 in the aftermath of the Financial Crisis, the index price has risen over three-fold and the MSCI World Index has doubled. Disappointingly, European shares have risen only one-third of the S&P’s price gain in the same amount of time and lagged global equities considerably. The question in our minds is whether this is a permanent condition or will European shares become competitive with other global equity markets. European equities do offer compelling valuation measures, particularly versus the US, but the macro pressures facing the Euro region, the uncertain outcome of Brexit and the absence of fiscal policy support may limit the price appreciation of shares in the region.
South Korean exports contracted over 11% over the past year marking the second consecutive month at negative levels. Many view this economic data series as an early indicator of global trade. South Korea is an export powerhouse with trading relationships throughout the world and region, particularly China and Japan. What is critical in our view is how long this trend persists — the contraction in Korean trade could turn out to be intermittent, fluctuating with periods of expansion as was the case in 2012-2013, or it could signal a more prolonged contraction with recessionary conditions that occurred during several periods over the past 20 years. Chinese economic growth will be a key factor and some see reflationary monetary policies gaining traction later this year and it appears that purchasing managers indices may be stabilizing, albeit below expansionary levels.
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.