The last week’s market highlights:
Quote of the week:
“Let’s be careful out there.” – Sergeant Phil Esterhaus, “Hill Street Blues”
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.S. economy: November jobs report shows there’s no reason to “flip” over an inverted yield curve
Last week was not one for the fainthearted.
Risk appetite was sapped by volatile oil prices, worries about slowing global growth, and concern that the U.S.-China trade dispute would escalate—a fear exacerbated when, at the request of the U.S., Canada arrested a top executive at Chinese telecommunications giant Huawei on grounds that the company violated U.S. sanctions on Iran.
Markets were also spooked when a portion of the U.S. Treasury yield curve inverted last week, with 2- and 3-year yields moving slightly higher than 5-year yields. (Typically, yields are higher on longer maturities than on shorter ones.)
Historically, an inverted yield curve has been seen as a harbinger of recession. But not all yield curve inversions have equal predictive power. The best indicator—and the one the Fed keeps an eye on—is the difference between 3-month and 10-year yields. And although the difference between these two maturities has narrowed, it’s a long way from inverting. Even if it were to do so, history suggests that a U.S. recession would likely still be one to two years away.
For now, the U.S. economy continues to demonstrate that there’s plenty of gas left in the tank. Last week’s data docket included these largely favorable reports:
- U.S. employers added 155,000 payrolls in November, and the unemployment rate held firm at a 49-year low of 3.7%. Average hourly earnings rose 3.1% year over year—unchanged from October’s increase but still the fastest pace in the current nine-year-plus expansion. The labor market remains tight, and if job creation were to average 155,000 per month throughout 2019, the unemployment rate would likely fall further.
Overall, these are perfectly respectable results at this point in the economic cycle and should help ease any recession-related jitters investors may be experiencing. For the first 11 months of the year, jobs growth has averaged a healthy 206,000 per month, above the monthly average of 183,000 generated during the same period last year. - The U.S. service sector, which accounts for about 80% of the U.S. economy, continued to hum, as measured by the non-manufacturing index published by the Institute for Supply Management (ISM). This index jumped to 60.7 in November, its second-highest level since August 2005. (Readings above 50 indicate expansion.)
- ISM’s manufacturing gauge climbed to 59.3, just above its impressive 12-month average. New orders, a leading indicator of future manufacturing activity, rose substantially.
- Consumers remained confident about the U.S. economy, according to December’s preliminary reading of the University of Michigan index. Sentiment has stayed at elevated levels throughout 2018.
Trade watch: In this corner…
In the ongoing heavyweight trade battle between the world’s two-largest economies, we think Beijing is negotiating from a position of weakness. First, China has been running a massive current account surplus with the U.S.—over $300 billion a year since 2012. Over that stretch, China has exported about four times as much to the U.S. as it has imported. This greater dependence on exports makes the Chinese more vulnerable than we are to the existing tit-for-tat tariffs, in our view.
Second, China’s economy is decelerating. In the third quarter, it registered its slowest rate of GDP growth since 2009. The fourth quarter hasn’t begun well, either. For example, in October, both credit growth and retail sales slowed. And in November, the country’s National Bureau of Statistics reported that service-sector activity hit a 15-month low, while manufacturing failed to expand for the first time since July 2016. Against this backdrop, Bloomberg forecasts further slowing over the next two years. Meanwhile, Chinese equities remain in bear-market territory. The Shanghai Composite Index has plunged more than 20% year to date.
To goose the economy, China’s central bank, the People’s Bank of China (PBoC), is expected to roll out further monetary stimulus. Earlier this year, the PBoC cut banks’ reserve requirements and injected cash into the banking system. These moves marked a strong policy shift from its previous attempts to quash excess lending and contain the financial risks that ballooned after years of credit-fueled growth. On the fiscal side, personal income tax cuts designed to lift household consumption will take effect in January.
Regarding trade, the only sure thing is that December 1 marked the beginning of a 90-day U.S.-China “trade truce.” When that period ends, U.S. tariffs of 25% on $200 billion of Chinese goods are scheduled to kick in. Less clear is what the two sides will be negotiating over during the truce. Some members of the Trump administration appear to simply want a narrower U.S-China trade deficit, which hit a record high in October. Others are more focused on resolving the thorny issues still on the table, including cybersecurity, forced technology transfers, and China’s alleged intellectual property theft. How accommodating Chinese President Xi Jinping will be on these matters remains to be seen. Uncertainty will abound as long as these questions remain unanswered.