Economic Recap – Faint Hints of a Trough
The large-cap domestic equity indexes continued to push to new highs this week. It’s always hard to peg why the markets do what they do short-term, but these three reasons have to rank reasonably high on any list:
– Optimism that a trade deal of some sort gets done before year-end.
– Chairman Powell talked again this week and basically said there are no hikes coming soon even if inflation ticks higher. There are also no plans to cut, but as always, they are ‘data dependent.’
– Finally, investors are pricing in a modest economic and earnings rebound next year. Certainly, the hard data hasn’t changed much, but there is growing hope that low rates and trade stabilization will feed through into a turn.
This last point is probably the most controversial given our conversations with clients this week. People can buy into the idea some sort of trade deal gets done if only for raw political reasons. Number two doesn’t get much push-back. But any talk about number three is more often than not greeted with a quizzical look.
And maybe this is justified. Certainly, evidence of a turn presented below is but a hint, a mere whisper of a rebound. You have to wonder what comes first – a more durable turn in the data or a market correction?
Are we Approaching the Low in Manufacturing?
Manufacturing has been the epicenter of the global slowdown in 2019. There are tentative signs this might bounce in early 2020. For example, the Richmond Fed index is signaling a bounce in the national ISM manufacturing index.
If you squint hard enough at the chart below it shows the last manufacturing ISM number was higher (I said you had to squint!). One data point does not make a trend, but ???
Granted, today’s industrial production number fell 0.8% in October. However, this was due in part to the GM strike.
Consumer Keeps Spending
No sign that the consumer is slowing. Friday’s retail sales number for October was up +0.3% and is up +3.1% year-over-year. Basically in-line with expectations.
There is a decent chance Christmas spending is solid. One straw in the wind was in Walmart’s third quarter earnings report. They lifted their annual profit forecast on the back of higher fourth quarter sales.
Is Europe Less Bad than we Thought?
It looks like Germany avoided a recession in the third quarter. GDP grew +0.1% quarter-over-quarter as higher spending by households and the government offset a downturn in its export-focused manufacturing sector. This means the German economy avoided a technical recession defined as two consecutive quarters of negative growth. I know this isn’t saying much, but it was better than expected.
Probably more interestingly, investor sentiment about the German economy has rebounded sharply. The Zew survey of financial market experts found that sentiment about the outlook for the eurozone’s biggest economy has increased from -22.8 to a significantly better than expected -2.1.
Yield Curves are Back to Normal
Remember all the yapping about inverted yield curves a few weeks ago and how this meant a recession was imminent? Well, that’s gone away as curves around the world swing positive. The first chart is the curve for the U.S.
And the Second chart is for Germany.
If nothing else this indicates central bank actions have been enough to get ahead of a recession. It is looking more and more likely this latest brief inversion is following the 1998 script and not the 2000 or 2007 examples, at least not yet.
Too Much Too Soon?
Now if you want to make the case the markets are ahead of themselves, you’ll appreciate the following. Estimates for fourth quarter growth look lousy. For example, the recent Atlanta Fed estimate is projecting growth of just +0.3%.
Another model from the New York Fed is at +0.4%.
Both models would imply that investors are jumping the gun on the economic rebound call. Maybe a scenario where we get a 3% to 5% correction to allow the fundamentals to catch up wouldn’t be a low odds bet. But these models have a spotty track record, especially when the quarter is only half over. Time will tell.
Should You Go About Poking the Bear?
Fidelity was out this week arguing that we actually saw a bear market this year in out-of-favor areas like small-caps and oil stocks as well as high-flying growth companies. They think the ‘bear’ is over.
Josh Brown had a great tweet earlier in the week on Fidelity’s report. Essentially, he is saying you shouldn’t taunt the market gods with upbeat projections
But this raises an interesting point. Really ever since the tech bubble burst bearish arguments are viewed as being rigorous and academic while bullish narratives are viewed as myopic and short-sighted. How else can one explain the esteem John Hussmann is still held in after incinerating investor capital over the last ten years.
Along the same lines, Michael Cembalest at JP Morgan put out a piece this week that struck a nerve.
“While recessions and bear markets are a fact of life, something peculiar happened after the Global Financial Crisis: the rise of the Armageddonists, which refers to the market-watchers, forecasters and money managers whose apocalyptic comments spread like wildfire in print and online financial news. I understand why: by 2010, investors had experienced two consecutive bear markets, each with equity declines of over 40%. It took several years for equity markets to recover each time, unlike the shallower, faster-recovering bear markets of the 1960’s and 1980’s. The dismal performance of consecutive 2001/2008 bear markets hadn’t been seen in decades, and is only comparable to parts of the Great Depression.”
He then summarizes the calls of a select group of Armageddonists and quantifies how much money would have been lost if someone had followed their advice:
“This chart is about the opportunity loss for investors that acted upon seeing their comments at the time. One example: $1 shifted from equities to bonds in 2014 in response to mega-bearish commentary would have underperformed equities by around 40% as the S&P 500, propelled more by earnings growth than by multiple expansion, rolled on.”
Ouch!! And the coup de grace:
“(This)…is not an exhaustive list; we could have included Bill Gross (“The Cult of Equity is Dying”, 2012) and Harry Dent (“The US Has Gone Over The Demographic Cliff And Markets Will Crash This Summer”, 2013) but we ran out of room.”
This sure resonates. Some of these guys still garner headlines with their latest utterances. And maybe they will be right. But the bigger picture is this is all just human nature at work. Bad news sells. Cembalest again:
“I also understand that mega-bearish news appeals to human negativity bias, a topic examined by Nobel Prize winner Daniel Kahneman in his 2011 book on the brain and human survival instincts, by political scientist Stuart Soroka who has illustrated the inverse relationship between magazine sales and the positivity of a magazine’s cover, and in a 2014 experiment in which a city newspaper lost two thirds of its readers on a day when it deliberately only published positive news.”
Have a good weekend.
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