Gut Check

The first quarter is ending, spring has sprung and the 2019 market has delivered handsome equity returns, low volatility and still no whiff of inflation. At the same time, the Fed has just pivoted dramatically in the face of slowing growth, and weak economic reports are popping up everywhere.

Financial markets themselves seem confused, with stocks looking like they are pricing in recovery while bonds remain unconvinced.

“If you manage money, it’s time for a gut check.”

S&P 500

SOURCE: FACTSET. AS OF MARCH 20, 2019

10Y-2Y

SOURCE: FACTSET. AS OF MARCH 20, 2019

If you manage money, it’s time for a gut check. This is a good opportunity to stare hard at the data, doublecheck

your favorite charts, guess your competition’s positioning and take a deep breath.

It’s tempting, of course, to do nothing.

GEORGES SEURAT'S A SUNDAY AFTERNOON ON THE ISLAND OF LA GRANDE JATTE

SOME INTERESTING DOTS

To be sure, Fed Chair Jay Powell has downplayed any narrative that the Federal Open Markets Committee had completed a stunning reversal, insisting rather that it was standing by and keeping an open mind about what might come next. Indeed, Powell’s favorite word during his March 20 press conference was “patient.” He argued that the U.S. economic outlook was good, even if growth had slowed, and that markets shouldn’t read too much into the lower rate forecasts from policymakers that are collected in the so-called ‘dot plot.’

This has been a standard message even as the Fed reset expectations throughout the winter. Entertainingly (for a central bank governor), he tried to illustrate this point during a March 8 speech comparing perspectives on some “interesting dots” to a pointillist masterpiece.

Recent data points are indeed hard to shape into a picture with clear resolution.

Shockingly weak U.S. retail sales numbers in December seemed to presage the measly 20,000 gain in non-farm payrolls in early March. Housing and auto sales looked wobbly, too. But much of this may be an extended distortion from the lengthy government shutdown and disruptive weather patterns. On the more encouraging side, unemployment rates, wage growth, confidence surveys and financial conditions continue to suggest a stronger outlook.

Perhaps the greatest long-term uncertainty for the U.S. economy remains just how much 2017 corporate tax cuts will deliver new capital investment that boosts productivity and helps extend the cycle. While the long-term effect remains an open question, analysts expect just 4% earnings growth in 2019 for the S&P 500 following last year’s 22.5% windfall.

The global data is every bit as blurred. Economic growth slowed significantly last year in Europe, Japan and China, but a few happier glimmers may be coming into view.

Certainly, Chinese authorities, who tried hard to restrain excessive credit growth in early 2018, have shifted course with both fiscal and monetary measures to support demand. Credit conditions have eased for non-state firms and signs of broader growth should reappear soon.

China’s recovery alone won’t improve prospects in Europe, but expectations across the continent are so low that even a little more export demand and slightly better consumer confidence could deliver growth that exceeds the European Central Bank’s current forecast of 1.1%. The ECB itself will help with extended liquidity for banks and still further delays in rate hikes.

Global trade, which has suffered from cyclical headwinds and a little from tariffs, may be near a bounce if you look at recent strength in the Baltic Dry Index and industrial metals prices. Resilient oil prices may also suggest solid global demand even as the U.S. ramps up its export supply.

COPPER PRICE

SOURCE: FACTSET. AS OF MARCH 20, 2019

As for political developments, it may be harder to paint a positive picture. Just as President Trump seems on the verge of a trade truce with China, he may follow through on his threats to slap tariffs on European auto imports. Brexit arrangements, intended to be settled months ago, continue to weigh heavily on businesses trying to make simple plans for trade and investment.

Early next year, markets may begin to worry about the potential impact of bold new economic proposals from Democratic candidates for president who usher a rising backlash against large corporate profits.

“It’s a great time for us to be patient and watch and see how things evolve,” said Chair Powell—and he may be right. Moreover, the Fed can afford patient vigilance as long as inflationary pressures remain muted.

Still, if he were completely honest, Powell would admit that the dots are never really clear and that economists still argue about what the picture looks like, even decades after the fact.

For investors, the task remains: stare hard at the dots they can see today and assess how they may align in the months ahead. So far, at least, Chinese policy support, American consumer strength and a mild European bounce still suggest a reasonably healthy outlook.

“For investors, the task remains: stare hard at the dots they can see today and assess how they may align in the months ahead.”