The last week’s market highlights:
Quote of the week:
“Vanity working on a weak head produces every sort of mischief.” – Jane Austen (Emma)
Each week, we present our featured topics in the context of the major themes listed below from Nuveens 2019 Outlook :
- U.S. economy: A slowdown, not a recession
- Global economy: Amid lower expectations, emerging markets could surprise to the upside
- Policy watch: Fewer tailwinds, stronger headwinds
- Fixed income: Rates likelier to rise than fall
- Equities: Late cycle but good value
- Asset allocation: A neutral stock-bond view
U.S. economy: That wasn’t so bad
Thanks to the government shutdown, the advance estimate of fourth-quarter GDP was released on February 28, four weeks later than scheduled. The economy grew at a 2.6% annualized pace, far slower than it did in the second (4.2%) and third quarter (3.4%), but at a faster clip than consensus forecasts of approximately 2.3%. And looking under the hood of the economy’s engine, the underlying details were stronger than the headline number suggests:
- Personal consumption rose 2.8% (annualized), a sign that consumers were in a shopping frame of mind.
- Non-residential fixed investment growth (6.2%) rebounded from a weak third quarter.
- Within that category, business spending on intellectual property was the standout, growing at a 13.1% annualized rate.
Inventory changes also provided a slight lift, which is consistent with the quarter’s healthy job gains. After all, employers wouldn’t have added an average of 232,000 payrolls per month in the fourth quarter if they weren’t planning to restock their shelves.
On the down side, trade was a fourth-quarter drag, albeit a small one. Imports (+2.7%) outpaced exports (+1.6%), which lagged due to the U.S.-China standoff, a weaker global economy and a stronger dollar. Residential investment (-3.5%) likewise took a small bite out of GDP. Higher mortgage rates and home prices have hurt the still-struggling housing sector. Last week, we learned that housing starts plunged in December to a two-year low. But in a sign that better times may lie ahead, building permits rose for the month of December and on a year-over-year basis. Permits are considered a leading indicator of the health of the housing market.
With the books closed on 2018 GDP (pending the final estimate later this month), one key question is: Did the U.S. economy grow at the psychologically important 3% annual rate? That depends on how one views the data. The answer could be “yes,” given the 3.1% year-over-year fourth-quarter gain. But the answer could also be “no,” based on the economy’s 2.9% pace over the full calendar year 2018 versus calendar year 2017.
One year from now, we don’t expect to be having a similar discussion. Hitting a “three-handle” GDP growth rate in 2019 will be exceedingly difficult for a single quarter, much less the full year. First-quarter data is already pointing to a slowing economy. On Friday, for example, the Institute for Supply Management reported that its manufacturing PMI had eased in February to 54.2, a two-year low. Amid the fading effects of last year’s fiscal stimulus and the Fed not likely to cut rates anytime soon, we’re looking for 2% to 2.5% growth this year. That’s not so bad, but it’s a notable slowdown from 2018.
China’s economy: That wasn’t so good
Chinese economic data is showing only tentative signs of bottoming. According to China’s National Bureau of Statistics (NBS), manufacturing activity declined for the third month in a row in February, with the NBS Purchasing Managers’ Index (PMI) falling to 49.2, a three-year low. (Readings under 50 indicate contraction.) The exports and employment subindexes both dropped sharply. One encouraging sign: New orders, a leading indicator, moved back above the 50 mark.
February’s downbeat PMI release comes hard on the heels of news that in 2018, the Chinese economy expanded at its slowest pace since 1990. For its part, the government isn’t sitting still. Indeed, it has adopted a series of stimulus measures to help lift economic growth:
- Issued bonds to finance new infrastructure. Local governments flooded the market with these securities and offered inducements to spur demand from banks.
- Cut taxes. To increase domestic consumption and confidence among businesses, who for years have complained about growing tax burdens, Chinese lawmakers rolled out a series of tax breaks and incentives.
- Eased monetary policy. The People’s Bank of China (PBoC) injected cash into the banking system and has repeatedly cut the share of deposits that banks must hold on reserve at the PBoC, thus freeing up money for investment and lending.
Evidence is emerging that these measures may be having an impact. Credit growth is on the upswing, in particular among cash-starved smaller firms. On the consumer side, online retail sales have skyrocketed, and home prices have edged up. More help could be on the way in the wake of President Donald Trump’s decision to extend the March 1 deadline for raising tariffs on $200 billion of Chinese goods.
An even bigger economic boost may come from Beijing’s plan to ease its crackdown on shadow banking, the unregulated segment of China’s financial sector. Shadow banking assets—a wide range of high-yielding, “off-balance-sheet” investment products marketed by banks, insurance companies and wealth management firms—jumped to around $10 trillion last year. In response, the government issued stiff regulations to curb the industry’s rise. But amid China’s economic deceleration, policy officials began to have second thoughts. Although they’re well aware of the need to scale back the country’s mountain of debt, they also know that these risky loans keep the economy well lubricated.
Equity investors haven’t waited for the economy to rebound fully. China’s Shanghai Composite Index rose 7% last week (+20% year to date), officially entering bull market territory. (A bull market is defined as a rally of at least 20% from its most recent trough.) Markets were stoked by optimism over the U.S.-China trade talks and news that MSCI will increase exposure to Chinese stocks in its flagship emerging markets benchmark index. Such a move, slated to take effect in November, could bring as much as $125 billion into Chinese shares, according to some estimates. With inflation low and its currency (the renminbi, or yuan) holding up reasonably well, China is unlikely to hit the stimulus brakes any time soon. That could mean more fuel for this sharp rally.