Current economic events
After more than two months of gliding higher, concern reentered markets last week that the lofty policy expectations of investors may not materialize. One factor was top Chinese and American officials indicating slower progress on a trade deal, highlighting further details to iron out on a handful of issues. Trade data also became increasingly in focus, with Chinese exports dropping 21 percent year over year in February and global trade shrinking in December by the most since the financial crisis. We believe trade concerns are probably here to stay for the time being but feel that a significant global trade war remains unlikely. Markets were also disappointed by the extent of the European Central Bank’s (ECB) stimulus measures after it announced additional bank loans and pushback of the timing for its first interest rate hike in eight years. Given the deterioration of the European economy and substantial cuts in its growth outlook from both the Organization for Economic Cooperation and Development (OECD) and the ECB, investors may have been looking for the central bank to respond with greater urgency and penalized European assets when that did not occur.
The U.S. data picture last week was much the same as the past couple weeks ― namely, with better sentiment appearing in high-frequency surveys but continued weakness in hard numbers.
- On the sentiment side, February’s Institute of Supply Management (ISM) non-manufacturing purchasing manager’s index (PMI) was surprisingly strong while Markit’s composite PMI survey showed the expansion picking up across the economy.
- Within hard numbers, only growth in new home sales and housing starts were demonstrably positive, contracting much less than they did in prior months. Other numbers, such as growth in domestic auto sales and construction spending, trended down.
- Additionally, after blowout numbers in January, the February nonfarm payrolls report had its weakest showing since September 2017, though the unemployment rate fell 0.2 percentage points to 3.8 percent and wage growth increased. The U.S. economy has shown resiliency to the global slowdown, but it’s clear that early 2019 has represented a downshift in growth. Still, more optimistic recent data indicates the slowdown is likely to remain modest.
Though the ECB captured attention with its stimulus announcement last week, improving European data may have deserved to garner just as many headlines. In past weeks we have cautioned about European optimism by saying that the data is negative. However, downtrends in data are moderating and last week’s economic data improved across the board.
- A survey from Sentix showed economic expectations improving with its headline business confidence number, which considers both expectations and the current situation, moving higher for the first time since August.
- Service sector PMIs from Markit were stronger across Europe, contributing to a pickup in composite PMI for the eurozone.
- Year-over-year eurozone retail sales growth jumped higher after a nearly stagnant reading in December while individual country industrial production numbers sequentially improved across the four largest European economies.
Moving to Japan, numbers were more mixed during the week. Though services PMI improved along with Europe, Japan’s leading economic index has continued to contract, a sign of lower growth going forward. While it’s too early to call an end to the downtrend, it appears that the eurozone and perhaps developed markets in aggregate may have bottomed in February and negative momentum may be neutralizing.
Emerging economies overall are looking weaker, with poor numbers from Asia hurting the notion that improvement is on the horizon. Standing out was the February contraction in Chinese exports, the largest since February 2016. While seasonality effects may have played a role, the number shows how the decline in global demand has impacted the relatively trade-dependent country. An exception from most of the rest of the world, Chinese service sector PMI from Caixin/Markit also weakened in February, contributing to a decline in overall composite activity. Even so, some stronger numbers out of Mexico and Russia mean emerging markets in aggregate look to have only a slightly negative impulse. Overall health still is quite poor but is supported by relative strength in Brazil and India.
U.S. equities are trending in a generally sideways fashion following superb early-year performance and strong fourth quarter business results as uncertainty surrounding the pace of earnings growth in 2019 and progress from United States-China trade discussions linger. First quarter releases and forward guidance, which begin in mid-April, are important upcoming data points. Our recently-revised year-end 2019 price target for the S&P 500 is 2,970, roughly 8 percent above Friday’s close of 2,743, based on a multiple of 18 times earnings of $165 per share.
Last week, U.S. equities trended down, consistent with a market that appears in consolidation mode, with the S&P 500 retreating 2.2 percent, its worst weekly performance of the new year. Last week’s weakness was widespread and broad based. Nine of 11 S&P 500 sectors retreated, led by the 3.9 percent declines of Energy and Healthcare. Utilities and Real Estate were the two sectors that advanced fractionally for the week.
Despite last week’s pullback, equity markets remain in a longer-term upward trend. Most notably, the bull market in U.S. equities turned 10 years old on March 9, dating to the financial crisis in 2009. While this current rally is among the longest in history, lack of excesses or “bubbles” in inflation, valuation or investor euphoria are among indicators pointing toward still more upside.
- Earnings for the S&P 500 continue to trend higher, albeit at a moderating pace. To a degree, the earnings landscape presents conflicting trends. Fourth quarter sales and earnings advanced roughly 6 percent and 12 percent, respectively, according to Bloomberg. Conversely, expectations for first quarter and 2019 results are less sanguine. Consensus expectations are generally for 2019 S&P 500 earnings within the $165 to $170 range, advancing roughly 6 percent over 2018 levels. Of near-term concern, equity prices have continued to inch higher as the rate of earnings growth in 2019 has slowed, a longer-term disconnect.
- Non-problematic inflation and relatively low interest rates, consistent with periods of slow-to-moderate economic growth, are among indicators suggesting that it is premature to conclude that a recession is imminent and the long-running bull market in equities is over.
The price trend of the S&P 500 appears at technical crossroads having advanced to ― while failing to surpass ― the widely-cited 2,800 resistance level. On balance, technically, the S&P 500 ended February modestly overbought but not overly so. The 2,800 level for the S&P 500 is proving to be a meaningful resistance level. The popular index has met or fractionally extended above 2,800 four times since last October while failing to trend higher in all four instances. As such, the S&P 500 appears rangebound until it is not, with 2,800 representing the near-term upward bounds. A breakout above 2,800 would provide support for further upside, consistent with a trading pattern of higher highs and higher lows. Among upcoming and potentially market-moving catalysts include a change in Federal Reserve (Fed) policy, China-United States trade agreement and first quarter releases beginning in mid-April.
Fixed income markets
Risk-off sentiment permeated global financial markets last week. U.S. Treasury yields moved lower while riskier high yield and emerging market debt spreads widened. Investors remained worried that slowing economies in Europe and China will drag down the U.S. economy. The ECB downgraded its growth and inflation expectations while indicating rate hikes are off the table this year. Weak data out of China and weak U.S. payroll data added to investor concerns. Strong exchange-traded fund flows into long-term Treasuries through January and February show investors have favored the safety of U.S. government bonds. We still believe strength in the United States should allow the Fed to hike rates at least once in late 2019. However, each week that passes during which U.S. data and sentiment do not recover decreases the odds of a 2019 hike. Next week’s Fed meeting is likely to tilt heavily dovish, a continuation of the “patient” approach of late, and in response to weaker data in China and Europe. We expect modestly higher Treasury yields due to expectations of a late 2019 rate hike, heavy supply, global central banks reducing net asset purchases and light foreign demand. We recommend reduced portfolio duration to minimize the negative price impact of increasing interest rates and to reflect the minimal compensation for extending maturities.
Higher quality investment-grade spreads held relatively flat last week while riskier high yield and emerging market debt spreads increased. Investment-grade corporates are slightly below long-term medians, though high yield and emerging market spreads are relatively expensive by historical standards. We are neutral, with a cautious bias towards riskier high yield debt due to high leverage in the space and the potential for rapid spread widening during periods of weak data and sentiment. Low defaults, improving credit fundamentals and fair valuations lead to our continued recommendation for a balanced allocation between high quality investment-grade debt and U.S. Treasuries.
With last week decidedly risk off and interest rates trading down to recent lows, real estate investment trusts and other defensive sectors were the outperformers. Utilities, after being big laggards for most of the year, gained 3 percent versus the broader market and are now trailing the S&P 500 by only 1 percent for the year. If the defensives are to continue their outperformance, we will probably need to see interest rates trade to new cycle lows.
Crude oil had a quiet week, with West Texas Intermediate (WTI) dropping 0.5 percent. For the year, WTI is still up 23 percent. Prices fell as inventory increased domestically and U.S. production remained at an all-time high of 12.1 million barrels per day. Prices could remain under pressure until there is a trade agreement between the United States and China. However, additional catalysts for price increases exist including an extension to the supply cut agreement between OPEC members.