For the week ending August 23
This summary is provided by Bryn Mawr Trust Wealth Management.
Global Manufacturing Weakness Persists
Purchasing Managers’ Index (PMI) figures released last Thursday, August 22, 2019, based on survey responses compiled by IHS Markit Group, revealed further weakness in the global manufacturing sector. The heavily export-driven German economy, which posted a slight decline in real GDP growth in the second quarter of 2019, was the negative outlier in terms of PMI readings.
PMI data is viewed as one of many leading indicators given that private sector participants respond to survey questions pertaining to new orders, inventory levels, production, supplier deliveries, and employment. Figures above 50 signify expansion, while numbers below 50 show a contraction in activity. IHS Markit Group is a separate entity relative to the Institute of Supply Management (“ISM”), which is viewed as a leading provider of global supply chain-based data and an alternative provider of PMI data. While economic findings from IHS Markit Group and ISM can differ to some extent, both entities have clearly shown a deceleration in manufacturing activity that started to unfold just prior to when global trade tensions began to take shape in early/mid-2018. The inability of the United States and China to reach an accord over trade-related matters has exacerbated the weakness in global manufacturing.
A manufacturing slowdown is troubling given the negative effects it can have on corporate profitability. However, as the following chart shows, the manufacturing sector has weakened to a below-50 reading two other times this cycle and a recession did not ensue. Most of the global economy is comprised of the services sector. This segment of the economy has also declined from elevated levels (see chart “PMI Services Data United States, China, Germany, and Japan – Ten Years Ending July 31, 2019”), but has yet to show marked deterioration, which could be interpreted as a much more ominous sign that a recession is on the immediate horizon.
PMI Manufacturing Data United States, China, Germany, and Japan
(Ten Years Ending July 31, 2019)
Source: FactSet, Inc.
PMI Services Data United States, China, Germany, and Japan
(Ten Years Ending July 31, 2019)
Source: FactSet, Inc.
Central Bankers Meet in Jackson Hole, Wyoming
News on the global macroeconomic front was disappointing this past week. The weakness in manufacturing coupled with recent downward revisions to corporate profits by the Bureau of Economic Analysis have clearly cast a negative shadow on markets. While we believe the odds of a recession are higher now relative to a year ago, the U.S. consumer has yet to “rollover” in our opinion and looks to be on solid footing, which we expect will keep the economy in expansion mode at least in the near term.
Various economists, financial market participants, academics, government representatives, and news media from all over the world congregated at the Federal Reserve Bank of Kansas City’s Economic Policy Symposium in Jackson Hole, Wyoming late last week. One take away is that Fed officials are clearly concerned about negative economic developments oversees and the consensus view is that the Fed seems inclined to offer more accommodation than what would normally be warranted given the strength of the U.S. economy.
More Tweets, More Equity Market Volatility – Wash, Rinse, Repeat
Last week, equity markets were on pace to finish with modest gains, thus breaking a streak of three consecutive weekly declines. However, further escalation of trade-related disputes between the United States and China last Friday sparked another round of downside equity market volatility. News broke that China announced plans to impose tariffs on $75 billion worth of U.S. products. President Trump retaliated with a series of tweets “ordering” U.S. companies to curtail business activities with enterprises domiciled in China and issued further criticism of Fed Chair Jerome Powell. While the president has no direct ability to effect such an order, this news nonetheless caused major stock market indices to decline nearly -3%.
For the week, the S&P 500 Index, a proxy for large cap stocks, fell -1.4%. Small caps, as measured by the Russell 2000 Index, fared even worse, declining -2.3%. International markets, both developed (MSCI EAFE Index) and developing (MSCI Emerging Markets Index) finished with modest gains but were closed after the trade war rhetoric hit the newswires.
Global macro developments clearly overshadowed a series of positive earnings announcements from companies such as Target, Lowe’s and Home Depot, which could be considered a barometer for the U.S. consumer. As expected, more defensive-oriented sectors, such as Utilities and Consumer Staples fared better this past week. The Consumer Discretionary sector was another positive outlier given some positive earnings data released by a few bellwether companies in the space.
Long-term Yields Drift Higher Then Fall
Yields on 10-year U.S. Treasuries drifted higher, then fell abruptly after the “flight to safety” trade took hold last Friday. For the week, the U.S. Treasury yield curve flattened, as the 10-year closed at 1.52%, while the 2-year rose 6 basis points and finished the week at +1.53%.
The inverted yield curve (long-term rates lower than short-term rates) continues to garner media attention as recession prognostications are becoming more mainstream. An inverted yield curve has preceded prior recessions and we are mindful of the negative effects such an occurrence can have on market sentiment. While the decline in long-term rates in the U.S. is clearly related to waning growth expectations, the decline is at least partially attributed to the increased demand of U.S Treasuries given negative interest rates abroad, which have pushed yields lower than what the economic fundamentals would justify. As result, we are not sure if the yield curve inversion has the same predictive power it once had in prior business and market cycles.
We’ve looked at equity returns proceeding various time periods after the yield curve inverted since the late 1960’s. Over a longer horizon, 7 to 10 years post inversion, returns were not materially different than historical averages. Longer-term returns were more a function of economic environments (1970’s stagflation, strong growth of the 1980’s and 1990’s, credit boom/bust periods of the 2000’s), path of interest rates, and equity valuation levels at the start of each period.
Closing Thoughts
We would not be surprised to see financial markets gyrate based on trade-related headlines, coupled with a seasonally weak period that has delivered below average returns in the past. Volatile markets will likely persist until there is at least some clarity on the global trade front. It is also not unusual to see higher levels of market volatility at the later stages of an economic cycle, which we believe to be the case at this time. That said, we would not encourage material shifts in portfolio allocations and believe that it is prudent for investors to focus on their longer-term investment goals and less on sensationalistic comments conveyed by the media.
