Current economic events
After holding up at a solid growth pace for months after the rest of the world began to decline, the U.S. economy looks to have finally caught up on the downside. Composite Markit purchasing manager’s indexes (PMIs) in the United States, an indication of private sector health, dropped below most of the world’s largest economies in August. Manufacturing PMI from the Institute of Supply Management (ISM) fell into contraction for the first time in three years. Despite softening private sector health, U.S. gross domestic product (GDP) growth remains above that of many developed peers. This is mostly a result of the continued strength and optimism of U.S. consumers, whose spending accounts for around 70 percent of economic activity.
While strong American consumers can support continued U.S. and even global expansion, they typically don’t cut back on spending until they start to worry about a weak future economy — sentiment driven heavily by the stock market and the news. In other words, it is a lagging indicator while business sentiment surveys, such as PMI, are better descriptors of where the economy is trending. With Google searches for “recession” spiking to all-time highs in recent weeks, solid consumer confidence surveys will be an important indicator of consumption behavior as other drivers of growth, as business investment and trade, stagnate.
U.S. data was mixed during the holiday-shortened week, with disappointing manufacturing data, varied labor numbers and a positive signal from the service sector. Despite a revision upward in Markit’s manufacturing PMI, it remains the worst reading since September 2009, while leading components of both the Markit and ISM numbers suggested potential for further weakness. Although factory orders returned to growth in July, the relief may be temporary; core readings continued to deteriorate and PMIs suggest continued August weakness. Construction spending data was also concerning, continuing to contract year-over-year at a rate rarely seen outside of recession. Labor sector data was unclear, with data from the ADP National Employment Report showing labor sector growth ticking higher and the Bureau of Labor Statistics’ nonfarm payrolls report depicting year-over-year job growth at its slowest rate since August 2011. The unemployment rate was unchanged and near cycle lows at 3.7 percent, while wage growth fell slightly but remains near cycle highs. Service sector PMI was a bright spot, with the ISM’s reading showing strength in this area even as the manufacturing sector contracted. The U.S. economy continues to trend sharply downward, with our proprietary “Health Check” average at a three-year low.
Developed European data was generally weaker last week. PMIs in the United Kingdom were worse across the manufacturing, service and construction sectors, with the composite reading showing a likely contraction of third quarter economic activity. GDP data showed Switzerland feeling some weakness, with second quarter year-over-year growth the lowest since the end of 2009. The German economy continues to struggle, with industrial production sharply contracting in July and the construction sector contracting at its fastest rate since 2014. Eurozone producer price data showed rising risks of deflation, with prices barely rising since last year. Meanwhile, data in developed Asian markets were mixed. Strength in Japan’s leading economic index and an eight-month high in composite PMI was balanced by recessionary PMI data in Hong Kong, as anti-China protests have escalated. Foreign developed economies continue to slow and are at their weakest point since late-2014.
Emerging market PMIs were mixed in August. China’s official reading and India’s composite softened while China’s private reading and Brazil’s composite strengthened. South Korea provided the latest example of tepid inflation across the globe, with consumer prices deflating for the first time since at least 1966. The South African economy bounced back hard in the second quarter after contracting at the fastest rate since the first quarter of 2009 in the first quarter. Overall, we see emerging market economies trending down, with some of the more peripheral countries like South Korea, Turkey and South Africa printing their worst data since the global financial crisis.
The S&P 500 ended last week up 1.8 percent, following the previous week’s 2.8 percent gain, marking the first two consecutive weeks of gains since July. Last week’s gains were largely attributed to optimism surrounding the United States/China trade discussions and technical price action, despite soft August payroll data and lingering concerns of economic slowing both home and abroad. The September 17-18 Federal Open Market Committee meeting and third quarter results beginning in mid-October are among upcoming catalysts expected to impact equity prices.
United States/China trade discussions continue to capture headlines and impact equity prices. While talks of an October meeting favorably impacted sentiment last week, the timing and magnitude of a new trade agreement remain unknown, with no indication that either side is willing to concede to structural issues. This suggests that trade deliberations are likely to be a source of market volatility for the foreseeable future. In addition, third quarter releases and forward guidance beginning in mid-October will set the tone for equity performance into year-end. At present, expectations are relatively low, arguably setting the stage for an upside surprise. As of the end of August, consensus is for third quarter earnings to decline 3.6 percent over year-ago levels, according to FactSet Research Systems.
Near-term, equity price trends seem as likely to be impacted by technical factors as much as fundamentals. The S&P 500 broke through the 2,840 technical resistance level last week, a level that has held for the past month or so. This sets the stage for potential further near-term upside in investor sentiment.
- The S&P 500 is beginning the week of September 9 above 50-, 100- and 200-day moving averages. The popular index is 6 percent above the 200-day moving average and 2.3 percent above the 100-day moving average, key levels of support.
- Despite widespread concerns about the pace of global growth and increased volatility among equities, the S&P 500 closed September 6 a mere 1.6 percent below the all-time high of 3,025 reached on July 26.
Overall equity performance continues to be superb and broad-based, fueled by restrained inflation, low interest rates and moderate earnings growth. As of Friday’s close, the S&P 500 is up 18.8 percent year-to-date, with all 11 S&P 500 sectors posting gains, nine of which are up 12 percent or more, led by the 31.1 percent gain of Information Technology. Broad market and sector strength are typically indicative of underlying economic strength or reflective of uninspiring alternatives. We continue to favor growth/cyclical companies and sectors over defensives, in addition to dividend-paying equities, absent ramping inflation and a looming recession. Approximately 60 of S&P 500 companies offer dividends yielding above the 10-year Treasury yield of 1.59 percent. Select companies offering dividends yielding around that of the 10-year Treasury yield and with double-digit dividend growth rates provide investors with both income and appreciation potential.
Our year-end 2019 S&P 500 price target of 3,135 is based on a multiple of 19 times earnings of $165 per share. The multiple of 19 is roughly where the S&P 500 currently trades on trailing 12-month estimates. Our price target could prove to be optimistic should the pace of economic slowing accelerate, thus elevating the importance of third quarter results and forward guidance.
Fixed income markets
Treasury yields rose last week, marking a brief reprieve from a downward trend that has persisted since late last year. Weak global economic data, uncertainty regarding trade tensions, short-term yields above long-term yields (inverted yield curve) and low inflation provide Federal Reserve (Fed) officials several reasons to cut interest rates. Market expectations for a 0.25 percent cut at the Fed’s meeting next week appear appropriate. Markets still price in multiple additional cuts in coming quarters, which would bring the policy rate near 1.00 percent by the end of 2020 from its current range just above 2.00 percent. The benefits of extending duration are limited due to low longer-term bond yields, both on an absolute basis and relative to shorter-term yields. We recommend investors hold portfolios with just below-benchmark duration. However, we caution against shortening duration excessively, given the important role of longer-term high-quality bonds in portfolio diversification.
Corporate credit spreads tightened last week as investors took incremental risk in stocks and riskier bonds. Investors were encouraged by the perception of easing trade tensions between the United States and China. Credit spreads are slightly tighter than 15-year historical norms, offering less compensation for incurring corporate credit risk than normal. A multitude of investment-grade corporations issued debt last week to take advantage of low yields. Demand for these securities remains strong despite the recent surge in supply. Agency mortgage-backed security spreads tightened last week but remains high relative to the last few years. We urge investors to maintain adequate holdings of high-quality bonds given their crucial role in diversified portfolios.
Crude oil, as represented by West Texas Intermediate, rose 2.5 percent last week and is now up 24.5 percent for the year. Fundamentals remain supportive, with another large decline in domestic crude inventories. Rig counts and domestic production also declined. However, the larger catalyst for higher prices was the improvement in relations between the United States and China. Given the large declines in U.S. inventories, any reduction in global growth concerns should add to crude prices.
Midstream infrastructure took a breather last week, giving back some of its gains based on Blackrock’s offer to purchase Tallgrass Energy Partners. Fundamentals continue to improve in the industry. The latest example is NuStar Energy, which will double the volume from its Corpus Christi export facility this month and triple the volume by year-end. This dramatic increase in volume is the result of two recently completed pipelines owned by Plains and EPIC that take oil from the Permian Basin into NuStar’s facility. The infrastructure to export U.S.-produced crude and natural gas is still under construction. The revenue growth potential for midstream companies is significant as more infrastructure is built out.
The gold market was relatively quiet last week, finishing the week down 1 percent. With $17 trillion in negative-yielding fixed income securities across the globe, precious metals have an advantage to a big chunk of the bond market. If this condition exists expect precious metals to rise higher.
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