For the week ending December 6, 2019
This publication is provided by Bryn Mawr Trust Wealth Management.
Enough Positive Signs Amid Mixed Economic Data to Push Stocks Higher
Equity markets started December on a negative note (-1.51%) as investors sold risk assets during the first two trading sessions. The move lower proved to be short-lived, but it was driven by worrisome trade headlines and disappointing manufacturing data provided by the Institute of Supply Management’s (ISM) Purchasing Manager’s Index (PMI). The manufacturing segment of the economy, based on data compiled by ISM, has now contracted for the fourth consecutive month. Late 2015/early 2016 was the last time there was this degree of weakness in the manufacturing sector. However, as appears to be the case today, previous manufacturing slowdowns this cycle proved to be temporary mid-cycle decelerations versus a catalyst for a broad economic recession. Although market bears may use the continued weakness in manufacturing as fodder for their negative view, we see enough evidence that manufacturing is bottoming and that the service sector of the economy will continue to be supported by a healthy consumer (see commentary on labor market).
We’ve written in the past that manufacturing in the United States would likely bottom sometime in the first quarter of 2020—but not before then. We believe that the effects of lower interest rates will finally start to work their way through the economy, and tariff de-escalation should serve to support business confidence. Therefore, we are not terribly surprised by the below consensus ISM Manufacturing PMI reading. One thing worth noting is that IHS Markit, an organization not affiliated with ISM, released manufacturing survey data that was more upbeat. In fact, IHS Markit’s Manufacturing PMI hit a seven-month high as new orders improved. The IHS Markit data is more domestically focused and should be less impacted by global concerns. Taken in combination, both data series corroborate a slowdown in the sector, but would also indicate early signs of improvement. In addition, manufacturing PMI’s outside the United States have started to move slightly higher from depressed levels (see chart below), providing further evidence that the bottoming-in-global-manufacturing thesis has merit.
Global Manufacturing PMI Data (>50 Expansion, < 50 Contraction)
(2 years ending December 2019)
Source: FactSet, Inc.
The delta, or rate of change, in terms of manufacturing, is important because stabilization could lead to a reacceleration in the global economy. In our opinion, the acceleration may not be as dramatic as prior periods since the Great Recession because of uncertainties related to trade and the upcoming U.S. presidential election; however, the market impact should be understood. Similar to 2016, more favorable developments regarding manufacturing could be a welcome sign for areas of the market like value stocks and pro-cyclical equity sectors. It also means that, although the Federal Reserve (Fed) is highly unlikely to hike rates, longer-term yields (i.e. 10-year U.S. Treasury rates) are probably well supported over the next couple of quarters and may drift higher. We still think it’s too early to assert that a cyclical upturn is well underway. However, as long as trade tensions between the United States and China do not escalate further, which we think is the most likely scenario, a stabilization in global growth will enable the economic expansion to continue for the foreseeable future.
Equity markets rallied Friday following a strong jobs report, enabling the S&P 500 Index to reverse losses from earlier in the week. Non-farm Payroll data released by the Bureau of Labor Statistics showed an increase of 266,000 jobs for the month of November. This was a very strong report even after stripping out the impact of the GM workers’ strike. In addition, year-over-year wage growth held steady at 3.1%, thus alleviating fears that elevated wage growth would cause inflationary pressures resulting in lower corporate profit margins.
While employment is a lagging indicator, we think it’s advisable to follow changes in weekly unemployment insurance claims (see chart below) which last week hit their lowest level since April of this year. Typically, this indicator starts to rise in advance of recessions, as evidenced by the chart below. Over this economic cycle, we have yet to see a persistent rise in initial unemployment insurance claims which, in conjunction with strong consumer confidence readings, should continue to provide a favorable backdrop for the U.S. consumer as 2019 comes to a close. This data helps support our view that a recession is unlikely in the near-term.
Weekly Initial Unemployment Insurance Claims
(50 years ending December 2019)
Source: FactSet, Inc.
Don’t get too far over your skis
While the equity market rally last Friday was encouraging, we should remain aware that stocks look a little overbought at the present time. This does not mean stocks can’t continue to climb in 2020, but an awareness of the heightened potential for a near-term pullback is important. With the S&P 500 up more than +6% since the start of the fourth quarter, one might argue that a fair bit of good news regarding things like trade is being reflected in current prices. Near-term corrections are always unsettling, but by simply acknowledging the higher probability of a pullback occurring, it should allow us to respond less emotionally if/when it occurs. Let us not forget: since 1927, the S&P 500 has averaged a correction of at least 5%, every 71 trading days, or about once every 3.5 months.
We believe that the 2019 equity market gains should be attributed largely to the Fed reversing course on its interest rate hiking campaign. Lower rates have encouraged multiple expansions (price an investor pays for a dollar of earnings), not earnings or revenue growth, and higher price-to-earnings ratios have been the predominant support for stocks. Higher multiples often leave the market more vulnerable to a correction that, in our view, would create a short-term opportunity to add equity exposure. The importance of maintaining a diversified portfolio cannot be overstated, particularly to mitigate the emotional impact of spikes in volatility.
