Overview
At the time of our last WorldView, back in November, markets had suddenly plunged, eventually leading to a painful stock market drop in the fourth quarter we hadn’t seen in a long time. And, even as the drop hit investors in the face, the causes for the shift were subtle, as the economy and political events had not materially changed from the previous few quarters.
Fast forward to today and, once again, so far in the first quarter the markets are surprising – this time to the upside – and, again, without a major single trigger. Markets were still expensive at the trough (though less so after the fourth quarter’s collapse) so what else changed?
In terms of actual actions, not much. But perceptions did improve on two main fronts.
First, the U.S. Federal Reserve changed its message over a short month and suddenly hinted that it may become more deliberate about future increases in interest rates. That said, it hasn’t reversed any previous rate tightenings. At least not yet.
Secondly, investors sensed an improvement in the tone of trade discussions between the U.S. and China and concluded that there may be a negotiated solution.
So it’s primarily about possibly fewer bad things in the future. The early 2019 strength brings U.S. stocks roughly back to where they started 2018, and it’s a part of the higher volatility that some have been warning about for some time.
North America
Tony M. Caxide, CFA®
Chairman - Senior Investment Council
Though we haven’t seen a GDP release in some time (owing to the government shutdown), several economic components suggest that we remain in decent shape, even if in early 2019 we’ll likely return to the moderate growth we’d previously experienced for years. Data like new jobs, manufacturing activity, and even consumer spending are growing at a pace that continues to reduce the unemployment rolls.
Why the possible slowdown from 2018? We feel it’s the echo of the forces that temporarily drove demand above normal. We are seeing a waning impact, for instance, in:
- The front-loaded government spending and tax cuts of last year, an unorthodox injection of stimulus done when business was already having a tough time finding qualified candidates;
- The business spending that was moved forward into 2018 to avoid anticipated tariffs; and,
- The strong capital expenditures in the mining sector that were driven by the strong gains in commodity prices (especially oil) in the first nine months of 2018 that then sharply reversed in the fourth quarter.
Japan
Jeffrey G. Wilkins,
Deputy Chief Investment Officer
Japan’s economy appears to have resumed growth in the fourth quarter, judging by the first print of its GDP figures, buoyed primarily by private consumption. Wage growth and mild inflation have been driving decent improvements in retail sales and household consumption, but inflation run rates are trending downward once again. As trade tensions and slower global growth weigh on exports, a further pickup in economic growth may require a significant U.S.-China trade deal or even greater vigor in domestic consumption.
Europe
Srinath Sampath, CFA®, PhD
Managing Director, Portfolio Management
At the final central bank meeting of 2018 in mid-December, ECB President Mario Draghi announced that the bank would halt new bond purchases through its stimulus program despite risks that were “moving to the downside.” At the January meeting, he acknowledged that economic risks were rising more than previously expected due to trade tensions, a messy Brexit, protectionism, and geopolitical risk. Weakening industrial production, car registrations, and purchasing manager index surveys more than offset the beneficial effects of declining unemployment and wage increases. Core inflation has been anchored at around 1% for a spell. With Italy entering a technical recession (posting two consecutive quarters of negative real growth) and Germany narrowly skirting one, the ECB will need to be intentional in the choice of instruments it deploys to guide this ship through today’s turbulent waters.
UK
Jeff (Shengde) Liu, CFA®
Managing Director, Portfolio Management
The uncertainty surrounding Brexit is finally taking a toll on the UK’s economic growth. GDP expanded to the lowly tune of 0.2% in Q4 2018 – a 0.4% drop from Q3 2018. This tepid growth stems from a weakness in construction, industrial production and business investment, with capital spending contracting in every quarter of 2018. Additionally, weakening numbers from purchasing managers in both the manufacturing and service sectors for January suggest that growth could stagnate as 2019 begins. On the bright side, UK inflation was lower than expected, running at 1.8% YoY. This was the first time in two years the CPI fell below the central bank’s target of 2%. Low inflation gives the BOE more room for stimulus if Brexit were to end badly.
Emerging Markets
Jeff (Shengde) Liu, CFA®
Managing Director, Portfolio Management
The trade war and China’s slowdown are the main culprits for the struggles in the EM market. On aggregate, China’s latest economic data releases were at their weakest level since 2015, and EM combined purchasing managers’ surveys slid into contraction territory in January of this year. While the service sector has held up better, it’s still trended down for two consecutive months.
Since the Trump-Xi truce meeting in Buenos Aires, three rounds of trade talks have taken place in Washington and Beijing. Progress has been made. The Trump administration is set to put off the March 1 deadline for raising tariffs on $200 billion of Chinese imports. On the economic policy front, China is ratcheting up its efforts to engineer a “soft landing” as it’s done before, but with a more incremental and refined approach. This includes fast-tracking infrastructure projects, cutting taxes, lowering bank reserve requirements and injecting liquidity into small businesses. These measured policies, however, have yet to turn the Chinese economy around.