Monthly Brief May 2019 – Business Conditions

Monthly Brief May 2019 – Business Conditions

CAPITAL MARKETS

The 2019 rebound in equity markets finally met its match in May. Heading into the month, investors debated whether global equity gains were the start of a new leg higher for markets, or simply a rebound from a late-2018 selloff that had gone too far, too fast? And efforts to answer this question were further complicated by a market driven by news flow rather than economic and corporate fundamentals.

The trade dispute with China has been front and center and, through April, the prevailing opinion had been that a resolution would be reached sooner than later. But the abundance of political rhetoric, along with pundits’ opinions often masquerading as “news”, only served to further obscure the true status of the discussions. Bond markets had not agreed with the optimistic view during early 2019 and, as equity markets continued to move higher, global interest rates drifted lower, suggesting bond investors had a less encouraging view on the state of the trade dispute. And, curiously, the equity market gains were occurring while economic fundamentals were deteriorating as reports ranging from corporate profits to general economic data were suggesting conditions to be softening.

May brought about a shift in sentiment towards a growing belief that the dispute may last for some time. Equity markets responded by moving lower through the month, while interest rates also continued to drift lower as slowing global economic growth became more concerning. As May concluded, sentiment was decidedly less optimistic, as was the general tone of the newsfeed, and fundamentals had become lackluster.

While the trade dispute is still with us, hopefully investors will now refocus on fundamentals, allowing a clearer picture of opportunities and risks to develop. And, we mustn’t forget the Federal Reserve’s ability to sooth sentiment concerns. Should they acquiesce once again to investors’ angst, any actions they take may very well be viewed as positive for equity markets, at least in the near term.

Global trade disputes, slowing economies, lackluster earnings growth, central bank interventions… The lazy days of summer don’t look to be in the cards for the capital markets in 2019.

CHART OF INTEREST – BUSINESS CONDITIONS

As tariffs moved from concept to reality, uncertainty has risen regarding the resiliency of the US economy. While the Federal Reserve remained confident enough to raise rates as recently as December 2018, investors have been skeptical that the economy could withstand both higher interest rates and global trade disruption. How critical these two topics have been is evident by the swift moves in the markets in response to any perceived new “information”. 

Now, it appears that this disruption is taking its toll. This chart tracks the past 20 years of the long-standing Institute for Supply Management surveys regarding the strength of the manufacturing and non-manufacturing sectors of the economy. The levels of these surveys suggest expected economic expansion when above 50 and expected economic decline when below 50, often corresponding with recessionary conditions.

These surveys have provided a good guide to the trajectory of the US economy and both have begun to soften over prior months as they have been trending downward. The good news is that each remain above 50 and in expansion territory. However, history suggests that when the trend is falling, the risks of a recession are rising, even before breaking below 50. And the manufacturing survey, in particular, has been in decline for a number of months and is approaching 50, which is certainly a warning.

While inconclusive today, these datapoints bear close watching.

James Ferrin, CFA
Chief Investment Officer


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