Monthly Brief December 2018 – Recession Risk
Following a decidedly bearish first three weeks in December, the US equity markets caught the holiday spirit and staged a mini-rebound into the year end. This has left investors to contemplate “what changed?” Were there positive developments in the trade war with China? None that were apparent, just more back-and-forth rhetoric. Was there new evidence contradicting the expected slowing in the growth rate of corporate earnings? Nothing new here. Has the Federal Reserve backed off further interest rate hikes? Their most recent public statement affirmed their expectation for further hikes, but did include language suggesting they are more open to curtailing increases sooner than later. Has the Brexit issue been solved? Not yet, but the deadline is quickly approaching.
So, what changed investor sentiment enough to suddenly cause a year-end bounce in equity markets? The consensus opinion suggests that technicals (price-related analysis) are flashing an “oversold” signal, meaning equity markets had fallen too far too quickly. If this is indeed the case, it speaks more towards a temporary condition than confidence in having hit a market bottom.
For a more durable market advance, clarity on at least some of the issues mentioned above will be necessary. And as that occurs, the bond market may provide a good commentary on whether a resolution to these issues will be viewed as positive or not. But the bond market did not agree with the equity markets year-end rally message as rates stayed well below the highs of 2018. Presumably, at this point in the economic cycle, healthy conditions would warrant higher rates and a steeper yield curve, i.e., the yield on a long-term bond would be greater than that of a short-term bond (currently, the differential is minimal in the bellwether US Treasury market). And, if we see these bond market characteristics in conjunction with positive developments in global politics, the post-2009 bull market may find it is able to reassert itself.
CHART OF INTEREST – RECESSION RISK
After a dismal fourth quarter in the equity markets, investors are contemplating if the declines are warning of more trouble ahead, or over-reacting to global political turmoil. While market volatility can certainly persist for months within a bull market, a more tangible risk of a lasting bear market would be signs of a global recession.
Currently, certain regions throughout the world are exhibiting higher risks, yet few signs point to a near-term synchronized global recession. But as markets struggle, earnings growth starts to slow and central banks examine current policies, it bears watching for signs of what may lie ahead.
Earlier in 2018 we highlighted the Citi Global Economic Surprise Indices provided by CitiGroup Global Markets, Inc. These indices measure how current economic data reports are exceeding or falling short of expectations (not necessarily if growth is positive or negative), with net positive reports providing a reading above zero and net shortfalls falling below. At that time, the US continued to have a positive reading, while the Eurozone was flashing a warning sign. Updating this chart through December, the picture looks to have changed with the US hovering just below neutral, while the Eurozone reading has again fallen after a few months of improvement.
No single datapoint can alone predict either the markets’ or economies’ next move. But this datapoint is cause for watching closely for additional signs of further global economic weakening. If found, continued global market volatility may be warning of something more than a technical correction.
James Ferrin, CFA
Chief Investment Officer
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