Why are we getting mixed signals from markets?
The primary question facing investors today is whether we will see a resolution to the tension between strong global equity markets and rallying bond markets. We are at a crossroads with all eyes on the US for an indication of what is next.
The primary question facing investors today is whether we will see a resolution to the tension between strong global equity markets and rallying bond markets. A muted outlook for growth, which we are seeing globally, is typically good for bonds and bad for equities, but there has been strong year-to-date equity performance that would normally indicate a more positive outlook for growth. We are at a crossroads with all eyes on the US for an indication of what is next.
- Interest rate cuts from the Federal Reserve (Fed) did not result in any steepening of the yield curve that markets were hoping for, and global yield curves are as flat as they were pre-2007.
- The health of the US consumer is not yet ailing, but if there is a profits problem, we may begin to see signs of this in the labour market data, which in turn would impact consumer confidence.
- Against a volatile market backdrop and mixed signals from equity and bond markets, we continue to see defensive assets like gold as attractive and are positioned with downside protection front of mind.
In under a year we have seen the Fed transition from a tightening cycle, before ‘pivoting’ to data dependency and a ‘pause’, to cutting rates by 25bps for the first time in 10 years and possibly embarking on a more sustained cutting cycle. Markets have disappointed after the 25bps rate cut, and despite having got what they wanted dropped following the news. Most importantly, the cut did not result in any steepening of the yield curve that markets were hoping for, and global yield curves are as flat as they were pre-2007.
Monetary policy’s impact beyond sentiment operates on a lag as well and given the rapid turnaround in the Fed’s policy trajectory in the last year, we may still see some negative effects from the tightening cycle feeding through, along with fiscal policy stimulus from tax cuts fading. In addition, for some time now we have been pointing to the possibility that central bank policy may not continue having the desired effect, and it is worth keeping the experience of 2001 in mind, where the Fed had to cut rates ten times to stem the eight-month recession.
Perhaps just as important for the path forward is the profit picture of corporate America, which is also not looking promising. While Wall Street is certainly giving the impression that corporate profits are at high levels, the National Economic Accounts data from the US Department of Commerce’s Bureau of Economic Analysis is painting a very different picture. Estimates continue to be revised lower, with retained profits no higher than 2014, and lower than 2012. It is worth being critical of important data like corporate profitability and given where price levels are it is worth being open to the prospect of National Economic Accounts data being more accurate than Wall Street. If this picture is correct, investors would have to be open to the US corporate sector having a profits problem. The health of the US consumer is not yet ailing, but if there is a profits problem, we may begin to see signs of this in the labour market data. If the labour market does start to weaken, then the widespread confidence about consumer resilience will be sorely tested.
Having faded for a short time after the G20 summit, trade tensions are very much back in play. With the Fed signalling that it has and may continue to cut rates to offset trade uncertainty, the US administration is able to use trade as a way of influencing the Federal Reserve to drive rates lower, ultimately what the administration wants. The tariff escalation is one component, while the US Treasury Department calling out China as manipulating its currency downwards (when it is in fact doing the opposite) is another. While our view is that we are in the early stages of a longer-term strategic rivalry between the US and China, shorter term tariff and currency tensions are certainly playing a role in the heightened volatility we have been seeing, and the feedback loop between the US administration’s trade policy and monetary policy leave the situation very hard to predict for investors.
As uncertainty begins to build after a mostly strong 2019, our focus remains on protecting investors’ capital, rather than being heavily committed to the risk rally. We continue to see defensive assets like gold as attractive and are positioned with downside protection front of mind.
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