Objects in Mirror Are Closer Than They Appear

Investment Risks Are Harder to Ignore.

Economists know that even the freshest data only records what has already happened, and their visibility of what may come is murky at best. Recent sightings in the rearview mirror look increasingly ominous as the U.S. enters a record 123-consecutive months of expansion. The faint glimmers ahead may well prolong it for a little while, but they had better get brighter soon or else be overwhelmed by the gathering gloom.

Policy responses to cut rates or boost government spending could extend this expansion further still, while new technologies may eventually help bolster some corporate profits. But investors making decisions should keep a close watch on capital spending and consumer optimism. Confidence in a robust fourth quarter remains high, for now. Spending and savings rates continue to rise, just not as much as initially suggested. Commerce data released Friday showed consumer spending increased 0.1% from July, its smallest gain in six months.  

Forecasts project growth through December, but these numbers, like consumer and corporate confidence, are showing signs of becoming increasingly cautious and measured with each month. The September jobs report due out this week should help sharpen that focus even further. 

“Do we even have the right map? Most disorienting for investors is the appearance of phenomena that have never been seen before.”

What’s in the rearview mirror?

Signs of a slowing economy are everywhere: GDP readings, industrial production and corporate profits have all been growing more slowly. Economic cycles do not end just because they are old; rather, it’s a combination of increased competition, stretched balanced sheets and weaker confidence all conspiring to produce tepid activity.

The outlook darkens further amid mounting trade tensions, which add to the costs of international commerce, increase uncertainty around supply chains and generally erode confidence. Talk of tariffs and sanctions has spread far beyond Washington and Beijing.

Markets have taken heart from persistent low inflation readings, but there’s a cloud for this silver lining too. While worrying less about the affordability of large debts on corporate and sovereign balance sheets, investors must now consider whether weak pricing pressures in a period of historically low unemployment mean that structural forces of globalization, technology and demographics are driving us toward deflation.

What’s up ahead? 

The trick, of course, is deciphering what and how much these gloomy historical data streams tell us about the weeks and months ahead. So far, for example, there are few signs that the American consumer has been reading the economic news at all. Job openings remain plentiful, wages seem to be rising and the recent fall in interest rates seems to have helped boost the U.S. housing sector. 

Markets can also look ahead to more supportive government policy. The Fed may not deliver more than one additional cut this year unless something dramatic changes, but it responded quickly to the recent disruption in money markets. Moreover, its latest adjustment has given cover for monetary easing around the world, including the European Central Bank, the Bank of Japan and the People’s Bank of China. Fiscal policy may also help on the margins. At the very least, the U.S. and China won’t be cutting spending; Germany may even spend a little more.

The real wild cards are stacked around business sentiment and fixed investment, which have both been battered by uncertainty around trade. Executives have likely delayed new projects until the dust settles and the world’s tariffs rates return to predictability. As long as relations don’t collapse altogether, however, firms won’t be able to hold off, and the investment cycle may start to recover.

GLOBAL PURCHASING MANAGERS INDEXSOURCE: FACTSET AS OF AUGUST 30, 2019

FIXED INVESTMENT GROWTH Y/Y% CHANGESOURCE: FACTSET AS OF JUNE 28, 2019

Do we even have the right map?

Most disorienting for investors is the appearance of phenomena that have never been seen before. Negative bond yields were not in anyone’s textbooks, and yet they now comprise a large share of fixed income markets. Asset price inflation and low volatility may be other unintended consequences of quantitative easing that persist as long as central banks are unable to bring their balance sheets back to pre-crisis levels. 

At the same time, the political system that shaped global affairs for 75 years may be coming apart at the seams. The way the U.S. and China learn to deal with each other will matter far more than post-war alliances with Europe or Japan. The future financial stability of India, Brazil and Russia have never been so consequential.

Finally, investors must cope with the fact that global demand in most of the developed world may be in secular decline as populations grow older. At the same time, the appearance of automated technologies that can replicate both human bodies and minds will create enormous pressures on business models and corporate profitability. Just how, for example, will people buy products and services if machines have taken over their jobs? 

Which way now?

Credit investors should proceed with caution, but U.S. markets will have opportunities if this tenuous twilight lasts. Equities may also edge higher if companies pay dividends that exceed bond yields, and some Emerging Markets may benefit from a global easing cycle that brings the dollar back into line. Meanwhile, keep a close eye on that rearview mirror. If corporate investment doesn’t recover, Americans won’t keep spending.