It was a volatile week for stocks, bonds, and commodities. Oil prices in particular managed to lose over 8% at one point on Tuesday. In general stocks were lower while bonds gained ground. Emerging equities stood out with a gain for the week.
Softening Global Growth…
The startling volatility in oil prices reflects at least three things. First, the supply outlook took a bearish turn a few weeks ago. Secondly, speculators in the energy markets have been crushed and selling by leveraged players has compounded on itself. Finally, the global demand picture looks soft given the evolving slowdown in global growth.
There are a number of factors playing a part. By now the softening housing market is a well told story, so we won’t get into it again. But other areas appear to be softening. As you can see below, non-defense capital goods orders are flirting with contraction.
Additionally, the growth outlook outside the U.S. has dipped again. For example, this week we found out that both German and Japanese growth contracted in the third quarter. Germany was down for the first time since 2015, as you can see below.
German automakers hit a production bottleneck in the third quarter trying to comply with new EU emissions standards (apparently it is taking longer than expected for VW to hack the system!!), and this pulled growth down. Beyond that, lower demand from China for German exports is a growing problem.
Along the same lines, global manufacturing in general is stagnating. As you can see below, the global Purchasing Managers Index for manufacturing contracted again in October (the services number improved).
Another measure comes from the consulting firm ECRI. They have a weekly leading indicator that has a solid track record. Generally when it falls below -5% we are moving into heightened recession risk territory (there was a false alarm in 2012). The index is now basically unchanged which implies slowing global growth but no recession in the next 12 months.
GDP tracking indicators from the Atlanta and New York Federal Reserve banks both currently stand at 2.7%. Indeed, it seems almost certain that the heat will come of the consumption numbers, which contributed 4 percentage points to growth in the third quarter; the retail sales numbers today pointed in that direction. That alone will likely temper the pace of growth.
…Is Leading to Lower Inflation Forecasts
The good news from this is that the inflation outlook is being tempered at the margin. For example, this week’s report for consumer prices revealed that while headline inflation ticked up to a 2.5% annual pace, the core CPI (which strips out volatile food and energy prices) edged down to 2.1%, the lowest since April and just above the Fed’s 2.0% inflation target (chart below).
Along the same lines, the Treasury market’s inflation forecast continues to project softer pricing pressure. For example, the spread for the nominal 5-year rate less its inflation-indexed counterpart fell to 1.85% this week. This implied inflation estimate reflects the lowest reading since February and is well below this year’s 2.16% peak in May.
Francis Scotland at Brandywine noted the following:
“The U.S. economy is not an island, capital markets react to divergences and the blowback from the global economy has started. In October, the U.S. equity market finally joined the selloff that was spreading across the rest of the world. Cyclicals have been trampled relative to safety, with investors signaling that U.S. growth may have peaked. The retreat in the stock-to-bond ratio also argues for the beginning of a pullback in the ISM manufacturing index, an early indicator of GDP growth. Domestic inflation could surprise to the downside, suppressed by a strong dollar and retreating commodity and energy prices. The CRB Raw Industrials Index has dropped almost 10% this year, often a prequel to peak profits. The Fed rarely raises rates—and has never shrunk its balance sheet for that matter—when this index is contracting, but has been doing both all year.”
The Fed May Be Paying Attention
There were hints this week that the Fed might be paying attention. A few days ago, Jerome Powell outlined a mostly positive view of the US economy but acknowledged the global economy is not growing at the same pace as it was in 2017. He described the global picture as a “gradual chipping away” at the pace of growth but said it is “not a terrible slowdown.”
Then on Friday morning Fed vice chair Richard Clarida underscored the Fed’s rising concerns with the global economy, warning that there is “some evidence of global slowing” and noting that policy is ‘getting closer to vicinity of neural and being at neutral would make sense.”
Immediately after the comments the dollar fell and bond yields dipped to their lowest level since October. Just as importantly, Clarida said that the Fed should pay attention to the (slowing) global economic outlook and said that he doesn’t expect “a big pickup in inflation next year.”
This doesn’t mean the fed won’t hike in December. They almost assuredly will move rates higher by another 25bp on the 19th (the odds are running at about 70%). Looking further out, the odds of a hike on March 20th are about 1 in 3, and they dipped materially this week, as you can see below.
We still think the Fed will hike in March, but a move in the second quarter is really up in the air if the data continues to soften.
Have a good weekend.
Published by Gemmer Asset Management LLC The material presented (including all charts, graphs and statistics) is based on current public information that we consider reliable, but we do not represent it is accurate or complete, and it should not be relied on as such. The material is not an offer to sell or the solicitation of an offer to buy any security in any jurisdiction where such an offer or solicitation would be illegal. It does not constitute a personal recommendation or take into account the particular investment objective, financial situations, or needs of individual clients. Clients should consider whether any advice or recommendation in this material is suitable for their particular circumstances and, if appropriate, see professional advice, including tax advice. The price and value of investments referred to in this material and the income from them may fluctuate. Past performance is not a guide to future performance, future returns are not guaranteed, and a loss of original capital may occur. Fluctuations in exchange rates could have adverse effects on the value or prices of, or income derive from, certain investments. No part of this material may be (i) copied, photocopied or duplicated in any form by any means or (ii) redistributed without the prior written consent of Gemmer Asset Management LLC (GAM). Any mutual fund performance presented in this material are used to illustrate opportunities within a diversified portfolio and do not represent the only mutual funds used in actual client portfolios. Any allocation models or statistics in this material are subject to change. GAM may change the funds utilized and/or the percentage weightings due to various circumstances. Please contact GAM, your advisor or financial representative for current inflation on allocation, account minimums and fees. Any major market indexes that are presented are unmanaged indexes or index-based mutual funds commonly used to measure the performance of the US and global stock/bond markets. These indexes have not necessarily been selected to represent an appropriate benchmark for the investment or model portfolio performance, but rather is disclosed to allow for comparison to that of well known, widely recognized indexes. The volatility of all indexes may be materially different from that of client portfolios. This material is presented for informational purposes. We maintain a list of all recommendations made in our allocation models for at least the previous 12 months. If you would like a complete listing of previous and current recommendations, please contact our office.