Macro Environment Update: Still Cloudy

Shortly after our blog post on December 11th highlighting the difference between 2018 and 2017 and asking the question: are we embarking on another global slowdown or a U.S. recession, the S&P turned in the worst December performance since 1931. Since the recent bottom on December 24, the S&P 500 has returned 17%. Has the volatility in markets lead to any changes in our outlook? In a word, no.

Our outlook called for a slowing, yet still a growing domestic economy, and that has not changed. Leading economic indicators, such as manufacturing and housing, continue to show weakness. The JPM Global Manufacturing PMI declined in January, marking nine consecutive months of decline. U.S. home sales, both new and existing, continue to be weak when viewed on a year-over-year basis, however, the U.S. ISM Manufacturing PMI continues to be strong.

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We are currently monitoring the areas of confidence, earnings, and employment within the U.S. economy and markets to see if they will continue to deteriorate. CEO confidence has recently dropped to the lowest level since the start of the recovery. This does not usually bode well for capex spending. Some of the recent weakness could be related to lack of clarity on trade policy and concerns about higher interest costs, which may be less of an issue in the next quarter. Since peaking in October, Consumer Confidence has recently pulled back but is still at very high levels. The bigger concern is the pullback in future expectations and the gap between the present situation. Weakness in this area may also be temporary, as policy uncertainty and higher interest rates have impacted consumers. Earnings growth estimates for 2019 have been coming down but are still positive. This could change if economic data gets worse or interest rates move higher. The employment picture in the U.S. continues to look healthy. The most recent non-farms payroll report showed 300,000 new jobs and a 12-month average of 233,000 new jobs. Although this is a lagging indicator, and likely too high a rate to sustain, the male and female participation rates of prime wage workers are near decade highs and the four-week average for unemployment claims is near a multi-decade low.

The U.S. continues to be the strongest part of the global economy. The weakness in the U.S. markets has been concentrated in the leading indicators and other areas most sensitive to the tightening of monetary policy. There is an ongoing debate as to whether the Federal Reserve is done hiking rates and if they are going to change their stance on balance sheet reduction. The markets have started to price in a lower Fed Funds rate in 2019-2021 and do not expect changes out of other major central banks like the ECB or BOJ. Even if the Federal Reserve is done hiking for the cycle, we believe the full brunt of the last two years’ worth of rate hikes has not been reflected in the current economic data. How the above mentioned mid- and late-cycle indicators perform during the course of 2019 will give us an idea of whether or not this is another growth slowdown or the start of a U.S. recession. At this moment, the data in the U.S. still suggests that a recession is unlikely to occur in 2019. If the data continues to weaken, suggesting a recession could occur in 2020, we expect risk markets to underperform as this outlook starts to become a reality.

The views expressed herein are presented for informational purposes only and are not intended as a recommendation to invest in any particular asset class or security or as a promise of future performance. The information, opinions, and views contained herein are current only as of the date hereof and are subject to change at any time without prior notice.

Rank Dawson, CFA, FDP

Senior Vice President, Investment Strategy
Boyd Watterson Asset Management, LLC