Overview
And then, out of nowhere….
October was a great example of how quickly things can change and why momentum investing is perilous.
In terms of macro-economic and geopolitical events, things were not drastically different. Though the GOP lost quite a few more House seats than normal in mid-term elections (37 so far, vs. an average of 26 for the party in power), divided government isn’t new.
But markets were another thing altogether.
Why? We think the forensic evidence points to 3 items. Oil prices dropped sharply, and the last time commodities were under pressure, earnings suffered. Further, the boost from a fiscal injection – always designed for a front-end impact in an election year – is beginning to wane and there are signals that demand is slowing. And then there’s that pesky little buzzing sound that we have described for some time – expensive risk assets like stocks and credit. Even Bitcoin, the mother of speculative assets, is collapsing.
North America
Tony M. Caxide, CFA®
Chairman - Senior Investment Council
The recent election and ongoing trade tussle were of modest economic and markets consequence, even as the rhetoric occasionally soared and roared. Looking out the side windows, growth is strong and inflation has even slowed a bit. But who cares about today? Markets certainly don’t. And markets are sensing weaker housing and a more moderate consumer ahead. Though overall data is currently robust, there are signs that middle- and low-income folks – those who tend to spend their incrementally earned dollar – are under some stress. That means falling auto sales and slowing borrowing, fewer iPhones, and cancelled cable/satellite subscriptions. This is peculiar, as this usually happens when new jobs slow materially (which they haven’t yet, not with a big dollop of tax cuts and borrow-and-spend initiatives) and interest rates rise a lot (only moderately, so far). But markets are sniffing a turn for the worse in both. And given elevated prices, there is little room for error.
Japan
Jeffrey G. Wilkins,
Deputy Chief Investment Officer
Japan’s GDP dropped slightly in Q3, reflecting minor weakness across most areas of the economy. While Japanese workers are now experiencing the first sustained wage gains in over two decades, they appear to be acting conservatively, saving their pay increases rather than spending them. Corporations are also doing quite well, however they seem to be reinvesting their record-high profits back into their businesses. The persistent dearth of individual consumption is one area that Prime Minister Abe may target with possible fiscal stimulus. With monetary easing still in place, new fiscal stimulus would make Japan’s dual pro-growth policies stand out further among most developed economies whose monetary policies are more neutral to tightening.
Europe
Srinath Sampath, CFA®, PhD
Managing Director, Portfolio Management
Growth in the eurozone slowed to 1.7% from 2.2% last quarter. The consumer is still quite strong, and unemployment has dropped steadily. However, manufacturing and services indicators have declined steeply. The bond purchase component of the European Central Bank’s quantitative easing program is scheduled to end this year, while lending rates are expected to remain low in 2019. But foremost in ECB President Mario Draghi’s mind and contributing to his ruminations on whether to extend and expand the stimulus package are the ongoing trade war between the West and the East and the bedlam that is Italy’s coalition government – forged on a platform of anti-immigrant and anti-EU populism and very much at risk of growing its deficit to 2.4 percent of GDP, triple the promised level. This is quite a far cry from Pax Romana.
UK
Jeff (Shengde) Liu, CFA®
Managing Director, Portfolio Management
Brexit is again in the spotlight as several of Prime Minister Theresa May’s ministers, including her chief Brexit negotiator, resigned from her cabinet because they regard her plan as a betrayal of the promises made to voters. May’s political survival as PM is now in question.
On the economic front, GDP registered its best quarter in two years with a pace nearing 2.5%. A record heat wave combined with the soccer World Cup helped consumer spending, with net trade also contributing. However, some forward-looking and coincident factors suggest the UK’s momentum is slowing. Manufacturing indexes are down from their highs of a year ago, and a recent service measure came in at its lowest level since March. Further, consumer credit growth as well as factory orders rolled over. Inflation, at 2.4%, is just below the Monetary Policy Committee (MPC) target. With oil prices collapsing, we expect fuel costs will drag CPI lower going forward, giving the MPC more maneuvering room.
Emerging Markets
Jeff (Shengde) Liu, CFA®
Managing Director, Portfolio Management
EM currencies have shown signs of stabilization after media coverage of the crises in Turkey and Argentina faded away, even as trade disagreements between the U.S. and China remain squarely in the media’s crosshairs. Some encouraging news has come out as President Trump and President Xi’s G-20 summit meeting in Buenos Aires draws near. However, the failure of the APEC to agree on a joint statement and U.S. Vice President Mike Pence’s forceful words aimed at China seemed to quash the optimism.
Affected by the trade conflict and an economic slowdown in China, EM economic growth is lackluster. EM manufacturing indexes fell this year, with service measures also struggling at “modest-growth” levels. That being said, the weakness in China has forced the government to pause its deleveraging process and start to add liquidity by reducing bank reserve ratios for lending as well as injecting over 1.5 trillion Renminbi to the economy. Additionally, some infrastructure projects that were suspended are now reopened, and personal and business taxes are being cut.