Global equity markets struggle to manufacture gains           

Brian Nick

The last week’s market highlights:

Quote of the week:

“And the sun took a step back, the leaves lulled themselves to sleep and autumn was awakened.”– Raquel Franco
Each week, we present our featured topics in the context of the major themes listed below from Nuveen’s 4Q 2019 Outlook :
  • U.S. economy: Still seeing signs of growth
  • Global economy: Downward pressure but no recession.    
  • Policy watch: Markets expect more easing  
  • Fixed income: Opt for high quality, longer maturity  
  • Equities: Get defensive, stay invested  
  • Asset allocation: While cautious, still prefer emerging-market bonds    

Global economy: The U.S. decelerates but remains a leader

After expanding at an annualized 3.1% rate in the first quarter of 2019, the U.S. economy generated just 2% GDP growth in the second quarter and now appears to be treading water. Consumer spending, which accounts for about two-thirds of GDP, has stayed healthy. But business investment, manufacturing and exports—three key economic cogs—have become headwinds.   
We don’t expect that story to change materially for the rest of 2019 or during the first half of 2020—not with the global economy continuing to feel the pain from the U.S./China trade war. In fact, that stress may worsen. The World Trade Organization recently downgraded its forecast for global trade growth for 2019, from 2.6% to 1.2%, and for 2020, from 3% to 2.7%.
Across the Atlantic, we think the health of Europe’s economy will hinge on the depth of the recession in manufacturing—particularly in Germany, the eurozone’s largest economy. German manufacturing activity fell to a 10-year low of 41.7 in September, according to Markit’s Purchasing Managers’ Index (PMI). (Readings below 50 indicate contraction.) Unfortunately, Germany’s not the only European country singing the factory blues. Italy (47.8) and Spain (47.7), the eurozone’s third- and fourth-largest economies, respectively, are also falling deeper into the manufacturing doldrums.
Eurozone service-sector activity has held up better, remaining in expansion territory (51.6) last month, although it, too, has decelerated. Even so, GDP growth for the region could fall short of 1% (annualized) in both the third and fourth quarter.
The U.K., meanwhile, is battling a toxic combination of a manufacturing malaise and deep political uncertainty. September PMIs hovered near a six-year low (48.3), as Brexit-fueled uncertainty dampened business confidence. In terms of Brexit, we don’t expect the U.K. and European Union (EU) to reach an agreement this year, and Parliament has, for now, prevented Prime Minister Boris Johnson from pulling the U.K. out of the EU without a deal. Instead, we expect Johnson to call a new election before year-end in a bid to restore his Conservative Party’s majority in Parliament. Doing so would make it easier for him to deliver Brexit next year, with or without a deal. The ongoing Brexit brawl will offer little help to the U.K. economy, which, like its continental counterparts, may be hard pressed to exceed 1% GDP growth over the remainder of 2019.    
Many emerging markets (EM) economies struggled as well during the third quarter amid the escalating U.S.-China trade war and U.S. dollar strengthening. Indeed, the dollar hit a 2½-year high versus a basket of currencies in September, according to the Wall Street Journal Dollar Index. (A more muscular greenback hurts countries and companies issuing dollar-denominated debt, as they’re forced to bear higher servicing and repayment costs.)
The key to transmitting growth across the EM sphere is a stronger Chinese economy. To that end, China is likely to enact further targeted stimulus, including personal and corporate tax cuts. This would be in contrast to the government’s more typical “kitchen sink” approach, which is to spur demand via monetary easing, currency devaluation and credit expansion. Regardless, we think the overhang of recession risk in Europe and trade-related uncertainty will prevent a meaningful near-term upswing in Chinese GDP, which fell to a 27-year-low of 6.2% in the second quarter. On the positive side for EM more broadly, financial conditions remain supportive, and low levels of inflation give central banks scope to cut interest rates.

U.S. economy: Perhaps best not to belabor poor manufacturing data

Investors tend to buy their biggest bag of popcorn ahead of what many see as the U.S. economic calendar’s feature presentation: the monthly nonfarm payrolls report. September’s employment figures, released on Friday, October 4, were more highly anticipated than usual because markets were eager to see if the recent slower pace of hiring has continued. Turns out it has. Monthly job creation averaged 177,000 from September 2018 through August 2019—a healthy number but down from 212,000 over the prior 12 months. And for calendar year 2019 to date, the average is a still-lower 161,000 new positions per month.
The employment report contained some disappointing news about wages, too: Average hourly earnings (AHE) stalled in September, reducing its year-on-year growth to below 3% for the first time in a year.
There were some bright spots, however:
  • While the headline figure of 136,000 new jobs added in September fell short of forecasts for 150,000, July and August payrolls were revised upward by a combined 45,000.

  • The number of unemployed workers has fallen, and the overall unemployment rate dropped from 3.7% in August to a 50-year low of 3.5%.

  • The U-6 “underemployment” rate unexpectedly edged down to 6.9%, a low last seen during the height of the late 1990s-early 2000s technology boom. (This rate encompasses both unemployed workers looking for jobs and part-time employees seeking full-time work.)

  • Average hourly earnings for nonsupervisory workers increased in September (+0.2%) and over the past 12 months (+3.5%), near their strongest pace of growth in the current economic cycle.
Equity investors generally breathed a sigh of relief that the U.S. jobs engine was firing on at least some of its cylinders. The S&P 500 rallied in the wake of the employment release, adding to Thursday’s gain and trimming losses from earlier in the week.
Last week the markets also digested disappointing U.S. service-sector data: The Institute for Supply Management’s (ISM) nonmanufacturing gauge fell from 56.4 in August to 52.6 in September, touching a three-year low.  
That release came on the heels of ISM’s manufacturing PMI, which retreated further into contraction territory (47.8) in September for its worst showing since June 2009. Not surprisingly, many of the survey’s subcomponents disappointed. In particular, new export orders and employment registered steep declines.
But in a case of “dueling PMIs,” a similar manufacturing indicator from Markit edged upward in September, to a lukewarm-but-still-expansionary 51.1. Why the discrepancy between the Markit and ISM numbers? Overseas developments. The ISM gauge tends to be more influenced by global economic growth and foreign earnings than the Markit metric. With the eurozone and China in the midst of abrupt economic decelerations, ISM’s reading has weakened to a greater extent. In contrast, Markit’s more domestically focused PMI is currently higher because of relative U.S. outperformance.
Regardless of which survey you follow, the important context is that manufacturing is only around 10% to 12% of U.S. economic output. Even so, September’s shaky PMI data has led markets to price in a faster pace of Federal Reserve interest-rate cuts. But with third-quarter GDP growth still in the 1.5%-2.0% range, we think it’s too soon for the Fed to begin aggressively easing. That said, an October rate reduction now seems like a foregone conclusion.
The Fed has begun to take the temperature of the global economy when calculating monetary policy, and the U.S. is about to slap tariffs on $7.5 billion worth of European goods, potentially fanning world trade tensions. Adding to the “cut rates now” side of the ledger: September’s pause in headline AHE growth.
This material is prepared by and represents the views of Brian Nick, and does not necessarily represent the views of Nuveen LLC, its affiliates or other Nuveen staff.
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