The last week’s market highlights:
Quote of the week:
“Crises and deadlocks when they occur have at least this advantage, that they force us to think.” — Jawaharlal Nehru
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
Global economy: Lowered IMF forecasts reinforce slowing growth theme
Last week kicked off with the release of the International Monetary Fund’s latest economic forecasts, which cover the entire world as well as individual regions and countries. The news was sobering, as the IMF downgraded its global growth projections for 2019 and 2020 by 0.2% and 0.1%, respectively.
These lowered forecasts represented the IMF’s second downgrade since July 2018. Somewhat surprisingly, growth estimates for the U.S. and China, both of which are visibly decelerating, were unchanged from the IMF’s outlook in October. This is largely because damage to the U.S. and Chinese economies from trade disputes had already been incorporated in that previous forecast. Since then, there has been no cause to lower growth expectations further, given apparent progress in trade talks between the two nations.
The story is different for the eurozone and certain parts of the emerging-markets (EM) universe. Specific drivers of slowdowns in these regions are now reflected in the IMF’s projections and accounted for the bulk of last week’s global growth downgrade. Germany, Turkey and Italy were the countries whose outlooks were lowered the most. In fact, Turkey alone caused the IMF to slash its emerging European growth forecast for 2019 by a whopping 1.3%.
Despite a gloomy overall tone, the IMF is not calling for recessions or even severe slowdowns in any major economy. This is consistent with Nuveen’s 2019 Outlook. Still, the IMF believes that risks to its growth outlook remain tilted to the downside given continued uncertainty around trade, Brexit, high levels of public and private debt, and potentially greater-than-anticipated slowing in China.
Europe seemed intent on living up (or rather, down) to the IMF’s expectations last week. Flash (preliminary) readings for Markit’s Purchasing Managers’ Indexes (PMIs) for January showed that both manufacturing and service-sector activity in the eurozone approached stagnation in January, hitting multiyear lows. The disappointing eurozone economy is a key reason we believe there are likely better investment opportunities in EM asset classes than in international developed markets this year.
On January 24, the same day the PMIs were released, European Central Bank (ECB) President Mario Draghi acknowledged that risks to the eurozone economy had shifted to the downside. Markets, interpreting Draghi’s comments as dovish, are now pricing in very little chance that the ECB will move to lift interest rates in 2019, as previously planned. In fact, there is even talk of reinstituting certain easing measures, though that remains a remote possibility.
For its part, China reported last week that its economy grew 6.6% in 2018, the slowest pace in 28 years. The deceleration was not unexpected, coming on the heels of December’s weaker manufacturing data, as measured by the Caixin China PMI. This index slipped to 49.7 last month, falling below the 50 level that separates expansion from contraction. While such a reading is discouraging, we think the massive targeted stimulus measures currently being deployed by the Chinese government offer significant upside potential to our outlook for China’s economy in 2019.
U.S. economy: Looking where the light is
Late one moonless night, a man dropped his car keys in an unlit parking lot and got down on his hands and knees to look for them. After half an hour of scooching around in the dark with his eyes scouring the black asphalt surface, he gave up in frustration and walked all the way back to the entrance of the lot. There, a single streetlamp provided a tiny circle of illumination. The man once again got down on his hands and knees and resumed the search for his keys. A passing police officer noticed him and asked if everything was all right. “I lost my car keys in the parking lot,” the man replied. “If you lost them in the parking lot, why are you looking out here?” the officer asked. “Because this is where the light is,” the man said.
It’s hard not to empathize with the man in this parable. Close to half of the U.S. economic data scheduled for January release has been delayed by the government shutdown. That means there have been a lot fewer streetlamps to rely on as we look for clues on the economy’s performance in December, and what they might mean for 2019.
Thankfully, The Conference Board is not run by the federal government, and it published its index of Leading Economic Indicators (LEI) last week. As expected, the index showed a slight worsening of leading indicators in the month of December and close to a 1% deceleration in their year-over-year improvement. Many of the variables that go into the LEI calculation are market-based—the S&P 500, credit spreads, and the yield curve, to name a few—so it’s not surprising to see a negative reading in December. In fact, the index reading would almost certainly have been worse had it not been for gangbusters employment data. (Fortunately, the Labor Department is one part of the government that has continued to operate.)
Based on what we’ve gleaned from January so far, we should expect the next data point in February to show improvement or at least stabilization. That said, there’s no denying that most leading indicators are softening. It’s the rate of softening that will determine whether the economy settles to a lower-but-comfortable altitude or experiences a bumpier landing sometime in 2020.
The Federal Reserve doesn’t seem to want to be the cause of any turbulence at this point, but that may be hard to avoid. Chair Jerome Powell will be holding a press conference on Wednesday, January 30, following the Fed’s January meeting. So even if the Fed’s policy statement fails to mention other potential economic headwinds—Brexit, the shutdown, trade—Powell will probably still be asked about them by reporters in the room. It’s likely the statement will continue to include some language about the need to maintain a degree of flexibility to raise rates somewhat further, which is bound to unnerve the markets. He may try to counterbalance that view with some preliminary plans about slowing or ceasing the reduction of the Fed’s balance sheet.
From our perspective, the biggest question mark is how Powell will characterize the government shutdown. He won’t want to stir anxiety by overemphasizing the uncertainty that the shutdown has caused, but he may well have to address both his best estimate of the shutdown’s economic impact, and the degree of difficulty the Fed has encountered in trying to do its job without nearly half of the data it’s accustomed to receiving.