Global equity markets are enjoying a swift recovery following their “distracting” adjustment last month. The S&P500 is up +5% over the first 10 trading days in June (thru 6/14), even as the trade dispute between the US and China is yet to show tangible signs of renewed repair. For the most part, improvement is being attributed to a more accommodating tone developing from Federal Reserve officials as they communicate their thoughts on the path of monetary policy and appear tipping their hat to a yield curve that is now inverted across some key maturities. The inversion in shorter-dated maturities is long thought a message that monetary policy is too tight for the economic conditions and outlook. It is in that regard that weaker economic data is now the market’s counter-intuitive friend. Just as strong economic data suggests to the Fed that tighter monetary policy is appropriate to keep the threat of inflation at bay, weaker data gives the Fed support to shift to an easier and more accommodating monetary policy even though the economic cycle is long. Bad news is good.
On the topic of economic fundamentals, there should be no illusion that the economy appears at risk of sliding into recession in the near-term. But, data is suggestive of a slowing pace since the start of May. Tariff uncertainty is probably at the heart of that reality: it hampers business confidence, and the latest thinking is that an extended trade war would actually be deflationary via constrained demand as opposed to an environment of inflation (very short-term). To that end, the most recent consumer price index data in both the euro zone and the US printed lower and below expectations; at the same time a soft non-farm payroll number and dip in US average hourly earnings also receive attention. Many find these data points surprising considering the very low unemployment situation in the US as it would ordinarily be thought to stoke wage pressure. But further supporting these twin concepts of deflation and economic slowdown is the swift decline in input commodity prices such as oil, copper, and etc as supplies are building in what is otherwise and traditionally a seasonal period where demand should be increasing.
Where to from here? When does softer economic data become a risk rather than a support? Tricky question, especially considering the current bull market is now tied with the longest in US history. We indeed live in a world insistent that we should always be worried about something. Yet it will likely come as surprise that a fairly comprehensive list of bull-market top signposts is flashing an all-clear signal. Investor and business euphoria as might be observed through aggressive flows into equity market funds is non-existent; IPO and M&A activity is healthy but not unchecked; corporate credit spreads (cost of borrowing) remain narrow. With those items in mind, as well as a Fed that seems on the cusp of easing before unemployment is rising or the economy is contracting (early ala 1994), it seems improbable that the US economy will suddenly slip into recession. But new highs for the equity market may be difficult to achieve without some resolution to current trade uncertainty. Higher prices and more restrictive trade is estimated to shave as much as 0.5% off full-year economic growth. For companies doing business internationally (most of the publicly traded equity market to an extent), trade disputes will reduce efficiency and make earnings growth more difficult to achieve. Without earnings growth, and uncertainty like trade making multiple expansion unlikely, the equity market may be “stuck” in a new range. Ultimately we believe that it is in neither the US or China’s best interests to perpetuate trade friction, but the urgency for to quickly resolve differences appears lacking with the 2020 US election still “too far” away. China may believe they can “wait it out” for a new, softer-on-trade President to negotiate with; and, Trump would prefer to have his economic numbers not peak “too soon” on an issue where most Americans – regardless of political orientation according to recent news surveys – believe China has played unfair for too long. This suggests we may have more wood to chop over the summer months.