Market Updates

A fundamental change in the Federal Reserve’s (Fed's) approach to achieving its inflation target means monetary policy is shifting from a headwind to a tailwind in 2020. The pattern of the U.S. business expansion over the past 10 years shares many similarities to the previous longest expansion in the 1990s. Like that episode, we believe the end-phase before the next recession could include a run-up in equity values way beyond historical norms.

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While some transient increases in initial claims and a modest rise in unemployment are possible in a lagged response to past Federal Reserve (Fed) tightening, unusually high uncertainty during the past four years has restrained investment and consumer spending, keeping real gross domestic product (GDP) below potential. This current lack of overheating still evident in below-target inflation makes a recession unlikely in 2020, as more accommodative policy bolsters demand back in line with potential, keeping unemployment around 50-year lows.

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While the macro trade data don’t suggest much pain or ill effects from U.S.-China trade tensions, state trade export data suggest otherwise, especially among many key battleground states. in a few key political swing states like Wisconsin, Florida, Pennsylvania and Michigan, the export picture is vastly different from the national figures.

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Investors are always looking for the best new idea. From a top-down perspective that means finding the countries with the most supportive innovation ecosystems and then digging deeper into sectors, industries and individual companies. The U.S.-China technology and trade conflict has brought two contrasting innovation ecosystems front and center as the countries race for economic supremacy. The stakes are high because both regimes believe whoever wins the innovation/technology war will win the economic war and will be in a stronger national security position.

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The swing in the U.S. from a major crude-oil importer to an almost-self-sufficient top producer has crowded out less-reliable exporters and greatly increased the security of supply, helping keep oil prices in check despite heightened geopolitical tensions and various supply curtailments this year. In our view, ample supply should also keep oil prices relatively stable in 2020, supporting our outlook for a global economic rebound.

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The hallmark of this record-long economic expansion has been recurrent fears of a relapse into the debt-deflation abyss of the 2008 financial crisis. Excessive pessimism set the market up for a favorable reaction to better-than-expected third-quarter earnings results. In our view, the stage is now set for a turn to the upside for 2020 corporate profits as the global economy begins the fourth mini-cycle rise of this record-long expansion.

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Data show people at the bottom of the income scale are generally feeling better about the economy than those at the top, a significant shift from the past four decades when the reverse was true. This strength in the low- and moderate-income sector is translating into relative outperformance so far this year by the stocks of companies that depend on them.

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The U.S. equity market can be analyzed and invested through many different lenses. A proper allocation can prove rewarding in managing risk and maximizing returns. Here we examine some trends and outlooks that have emerged across styles, sectors, market caps and factors.

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Central-bank easing and fiscal stimulus in a growing number of countries together with the Fed’s pivot from hawkish to dovish appear to have arrested downward global-growth momentum. Economic data have indeed become more mixed rather than outright negative. However, U.S. and global sentiment data have remained very weak, the yield-curve inversion has persisted, the dollar has continued to strengthen, and stress in the overnight interbank lending market has amplified, all signs that the Fed has still not added enough liquidity to maintain financial system stability, stimulate growth, relieve fears of recession, and preclude inflation from falling further below its 2% target over the coming year.

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Signals that global economic momentum is likely to turn higher in 2020 despite the persistence of the trade war are starting to accumulate. Broad indices of leading indicators are turning up. The global manufacturing Purchasing Managers Index (PMI) looks to have bottomed in July. Deglobalization began with the 2008 financial crisis and is likely to continue as two somewhat separate spheres of economic activity coalesce around the U.S. and China. This restructuring will require major increases in capital spending as supply chains are rerouted.

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With most central banks in easing mode, the direction of global growth will likely play an outsized role in the direction of the dollar over the rest of the year. The dollar is expensive versus most major currencies, so to the extent the global monetary easing cycle leads to a stabilization and eventual pickup in global growth, the dollar should stabilize or move lower. In the short-term, however, elevated global policy uncertainty, strong domestic private sector growth and a muddy global growth outlook should keep the dollar well bid.

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Recent volatility in the money market shows the Federal Reserve's provision of reserves has been insufficient. As the Fed reverses its quantitative tightening program and begins to provide more liquidity to the global financial markets, we believe economic data should continue to improve, making a U.S. recession increasingly less likely.

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The fourth wave of cyclical upswing in this record-long U.S. economic expansion has been delayed by prolonged policy uncertainties, including (1) an overly “patient” Federal Reserve; (2) three years of Brexit indecision, and (3) an extended trade negotiation between China and the U.S. As these factors head toward resolution, the global economy and risk markets are starting to sniff out the resulting turn in global economic momentum, causing economically-sensitive stocks to recently outperform.

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The deflationary shock that excessive Federal Reserve tightening delivered to the global economy in 2018 continues to spread and deepen, causing the dollar to strengthen, commodity prices to weaken, breakeven inflation rates to plunge well below central-bank targets, and global interest rates to sink to new all-time lows. It’s very important, in our view, that the U.S. central bank get more assertive about hitting its inflation target.

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Despite a strong labor market, elevated consumer confidence, weaker global manufacturing and trade growth, negative tariff-related sentiment, and an inverted yield curve, we continue to believe that a recession is not baked in the cake and can still be averted. While we are not surprised to see a rising risk of recession, we believe the Fed can do more to avoid one. Recent calls for the Fed to paradoxically subvert its own policy goals for political reasons in the name of “independence” undermine confidence in a favorable outcome.

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