16 Dec 2019
U.S. Stocks Remain Fairly Elevated but Are Off Their All-time Highs; Trade Headlines Continue to Drive Larger Market Swings
After a near-two-month lull on the trade news front, a surge in investor optimism, and reduced fears of a near-term recession, U.S. stocks remain fairly elevated but are off their all-time highs. Trade tensions between the United States and China briefly resurfaced after recent reports that a “phase one” deal may not happen by year-end. Accompanied by November’s weaker U.S. manufacturing and construction data, renewed trade uncertainty helped stoke fears that an uptick in domestic economic growth may not be as imminent as many had hoped. The initial rally to new highs for U.S. stocks was led by cyclical sectors, but some defensive sectors have since taken back the lead; suggesting that investors are not fully convinced of a near-term economic rebound.
Aside from the ongoing tug-of-war between cyclical and defensive sector leadership, small-cap stocks have failed to meaningfully break out and overtake their large-cap peers; and international indexes have not confirmed the new highs seen in the United States. Nonetheless, U.S. stocks have mostly ignored mediocre economic data and weak earnings growth; focusing instead on trade optimism. In turn, some measures of valuation have climbed quite markedly; and we may be approaching a point when earnings growth will have to do more of the market’s heavy lifting.
The aforementioned weakness in U.S. manufacturing reinforces the narrative of the still-firm dividing line between the manufacturing and services sectors. November’s Institute for Supply Management (ISM) Manufacturing Index missed consensus estimates and fell to 48.1; while the Non-Manufacturing Index ticked down to 53.9. Though the latter also missed estimates, the overall level remains above 50, which separates expansion from contraction and suggests that services remains relatively strong. Given the still-healthy consumer and gradual fading of trade tensions, investors had hoped for a pickup in activity synonymous with the recent improvement in global The global Purchasing Managers’ Index (PMI) has continued to rebound on a year-over-year basis; thus diverging from the U.S. manufacturing and services measures. By no means does this suggest the entire globe has shifted into growth mode, but data of late has trended favorably.
Global manufacturing is showing some signs of life
Some pundits and investors have dismissed still-soft manufacturing, pointing to its increasingly smaller share of the total U.S. economy. Yet, the reality is that it is more cyclical in nature—with a higher correlation to corporate profits—and tends to lead the rest of the economy. In other words, manufacturing punches above its weight. Absent a meaningful rebound in soft or survey-based measures (such as the ISM indexes) and hard data (such as industrial production and business investment), manufacturing’s malaise may start to spill over into services, with employment being the main transmission mechanism. Fortunately, the labor market has remained firm.
Just another mini-slowdown?
Among the myriad economic data that hit the press around the Thanksgiving holiday were the revisions for third quarter gross domestic product (GDP) growth. Original estimates from the Bureau of Economic Analysis (BEA) showed a 1.9% annualized growth rate, which was revised upwards to 2.1%. Strength in revisions wasn’t broad-based, though, as inventories accounted for nearly the entire increase; while imports and state & local government spending were revised downwards. Though revisions surprised to the upside, growth expectations for the fourth quarter suggest further slowing in the economy—as the Atlanta Fed’s latest GDPNow forecast came in at 1.5% as of December 5, 2019.
Another descent for the Leading Economic Indicators (LEI)
While the LEI’s weakness suggests we are later in the economic cycle, we haven’t yet reached the average level that has signaled past recessions. The jury is still out as to whether this is just another mini-slowdown (similar to 2011 and 2016) or something worse, so data in the next few months will give a more certain tell about growth prospects. Our view has been—and continues to be—that trade is the biggest needle-mover with regards to how much longer this cycle can last. Should uncertainty persist and a deal remain elusive, corporate confidence will likely remain under pressure and further strain investment; potentially affecting the consumer and labor market. Any détente or “skinny” deal would likely, at best, herald a stabilization in growth.
Trade has been a tough trade and dictated market moves
Up until last week, investors had grown increasingly optimistic and complacent that a “phase one” U.S.-China trade deal was near completion and would be signed by year-end. No news had been the best news, as the silence from both Washington and Beijing for most of October and November helped push the market to new highs. Yet, stocks resumed choppy trading after renewed hesitation that a deal was to be completed this year—bringing uncertainty back into the light and confirming that the market is still largely beholden to trade news.
While trade optimism has at times provided a meaningful lift to stock prices, the bite has clearly been equally as painful. In fact, as per our own findings, the market has moved nearly twofold on days when trade news is front and center, compared to days when there are no major headlines. Thus, as we have warned in prior reports, trading around short-term trade news has proven to be quite a treacherous task.
For the most part, the U.S. consumer has remained relatively strong, save for some deterioration in hours worked and paltry wage growth. Consumer confidence remains elevated and has stayed in a tight range since the start of the trade war, which stunted its climb in late 2018.
Consumers are waiting for positive news
Further escalation in trade tensions could hurt the stock market and hike prices on consumer goods—thus leading to a pullback in spending and weaker confidence. A significant decline in confidence has historically not bode well for the economy; and since the consumer has been among the few bright spots, any meaningful deterioration in confidence might shorten the runway between now and the next recession.
U.S. stocks continue to trade near their all-time highs but recent hiccups in trade talks have re-emphasized that a deal remains elusive, decisively unpredictable, and incomplete. Key components of the first phase have yet to be put in writing and major structural issues—such as intellectual property theft and forced technology transfers—will remain unaddressed for the foreseeable future, confirming that little-to-no material progress has been made. Persistent uncertainty has proven to be a significant strain on business confidence and spending, especially in the United States. Yet, the rest of the globe is showing nascent signs of emerging from the growth slump—bucking the usual trend of following the lead of the United States. Considering sluggish domestic growth expectations and a trade scenario that can tip in either direction, we maintain our neutral stance on U.S. equities (with a bias towards large caps relative to small caps), as well as developed and emerging market equities. We continue to encourage investors to use volatility to rebalance back to strategic long-term allocations.
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All expressions of opinion are subject to change without notice in reaction to shifting market, economic or political conditions. Data contained herein from third party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.
Diversification and rebalancing a portfolio cannot assure a profit or protect against a loss in any given market environment. Rebalancing may cause investors to incur transaction costs and, when rebalancing a non-retirement account, taxable events may be created that may affect your tax liability.
Forecasts contained herein are for illustrative purposes only, may be based upon proprietary research and are developed through analysis of historical public data.
The Institute for Supply Management (ISM) Manufacturing Index is an index based on surveys of more than 300 manufacturing firms by the Institute of Supply Management. The ISM Manufacturing Index monitors employment, production inventories, new orders and supplier deliveries.
The Institute for Supply Management (ISM) Non-manufacturing Index is an index based on surveys of more than 400 non-manufacturing firms by the Institute of Supply Management. The ISM Non-manufacturing Index monitors employment, production inventories, new orders and supplier deliveries.
Indexes are unmanaged, do not incur management fees, costs and expenses, and cannot be invested in directly.
The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc, and the source of comments provided here.
About the author:
Liz Ann Sonder, Senior Vice President, Chief Investment Strategist, Charles Schwab & Co., Inc.
Jeffrey Kleintop, Senior Vice President and Chief Global Investment Strategist
Kevin Gordon, Senior Specialist