The last week’s market highlights:
Quote of the week:
“Not what we say about our blessings, but how we use them, is the true measure of our thanksgiving.” – W. T. Purkiser
Each week, we present our featured topics in the context of the major themes listed below from the Nuveen Q4 Outlook:
- U.S. economy: Still running ahead of its peers.
- Global economy: Trade a bigger concern outside the U.S.
- Policy watch: Trade risks haven’t bitten the U.S. yet, but that may change.
- Fixed income: Continue to position for rising rates.
- Equities: The price is right outside the U.S.
- Asset allocation: Finding pockets of opportunity.
U.K. update: Breaking bad?
The United Kingdom is quickly moving toward its March 2019 breakup with the European Union (EU). However, the terms of the final Brexit agreement, should one ultimately emerge, have yet to be determined.
Last week, Prime Minister Theresa May and the EU agreed on a draft declaration on the U.K.’s future relationship with the EU. Parliament will vote on the deal in December. If it doesn’t pass—a distinct possibility since many within May’s own Conservative Party have vowed to block it—the options are all unsettling. They include trying to renegotiate a better arrangement with an impatient EU, which holds all the cards; holding a second Brexit referendum; bringing a revised deal directly to voters via a referendum, which May had formerly pledged not to do; and “crashing out,” or leaving the EU without an agreement in place. This last scenario would likely be the most disruptive, creating extreme uncertainty for consumers and businesses.
The U.K. is an open economy, with trade making up almost two-thirds (62%) of its GDP. Because of this, the relative strength of its currency, the pound sterling, greatly affects its economic fate. Moreover, the U.K. trades nearly as much (49% of GDP) with the EU as it does with the rest of the world. The pound’s drop versus the euro over the past year or so has benefited U.K. companies by making their exports more competitive compared to their Eurozone counterparts. However, the decline has been less helpful for consumers, who have been forced to pay higher prices on imported goods.
Opinions differ on the severity and timing of the economic or market response if a “crash out” Brexit were to occur. In such an event, we would expect at least a minor U.K. recession, a fall in the pound, and rising inflation—in other words, a period of stagflation, which is historically rare. Against such a backdrop, a correction in U.K. equity and real estate values would be likely, albeit one varied by sector and quality. Clearly, this isn’t a situation that any central bank would wish to contemplate. That said, the Bank of England, led by its experienced governor, Mark Carney, is viewed as a steady hand in times of turmoil, capable of providing stability in a worst-case outcome.
U.S. economy: Is the housing market standing on shaky ground?
Housing numbers overall have been disappointing in 2018. Residential investment has been sluggish, as the private sector has focused more on upgrading machinery and software. Most construction has been for commercial purposes, although that portion of the real estate market has softened as well. Last week, the housing sector once again received mostly negative news:
- Homebuilder sentiment plunged in November to its lowest level since August 2016, according to the NAHB/Wells Fargo index. The press release accompanying the data noted that multiple headwinds have hit builder confidence, including shortages of lots and labor, rising costs, reduced housing affordability, and higher mortgage rates.
- Housing starts increased 1.5% in October but fell 2.9% compared to a year ago. Meanwhile, building permits, a forward-looking indicator, declined both for the month of October and versus last year.
- Existing home sales broke a six-month losing streak by climbing 1.4% in October. But sales have fallen 5% over the past 12 months, their eighth straight year-over-year slide.
The silver lining to this discouraging data is that housing now makes up less 4% of U.S. GDP, down from almost 7% at the height of the housing bubble leading up to the financial crisis and Great Recession. This means that a housing pullback now would act as less of a drag on the broad economy. In addition, household balance sheets are far healthier than they were then. Mortgage debt-to-income is well below its 2007 peak.
Other data releases from last week were mixed:
- Consumers are still bullish on the economy, according to November’s final reading of the University of Michigan index. Sentiment has stayed at elevated levels throughout 2018.
- The Conference Board’s index of leading economic indicators rose in October, marking its 13th consecutive monthly advance. While the commentary accompanying the release calls for short-term economic growth to remain robust, longer-term growth is expected to moderate, to about 2.5% by mid-to-late 2019. We agree that the economy’s expansion has peaked and forecast GDP growth of about 2.3% for 2019 as a whole.
- On a down note, orders for durable goods (aircraft, machinery, computer equipment, and other big-ticket items) fell 4.4% in October. Orders for core capital goods, often viewed as a proxy for business investment, edged down last month following small drops in September and August.
This week will bring more housing data, including home prices and new and pending home sales. Also on the docket are the government’s second estimate of third-quarter GDP growth, core inflation, and various measures of consumers’ economic health, including confidence, spending and personal income.