Written by Jim Welsh
Macro Tides Monthly Report 02 January 2020
Markets Are Priced for Perfection, Not Disappointment
The U.S. stock market ended 2019 with a record run based on a Phase One trade deal with China, institutional Fear Of Missing Out (FOMO), projections by the Federal Reserve that interest rates will not change in 2020, and expectations the U.S. and global economy will strengthen in 2020.
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This expectation is critical since S&P 500 earnings were basically flat in 2019, so the entire gain in the S&P 500 in 2019 was due to a 30% expansion in its Price Earnings ratio. At the end of 2018 the P/E Multiple for the S&P 500 was less than 14 times and a touch over 18 at the end of 2019.
The last time it was this high was in January 2018 which was followed by 11 months of indigestion and ultimately a sizable correction in the fourth quarter. Investors don’t expect a repeat since the Federal Reserve increased the federal funds rate 4 times in 2018 and the December 2019 Dot Plot by members of the FOMC indicate that 13 of the 17 members are expecting no change in the funds rate in 2020.
Ed Yardeni is a long time Wall Street economist who has distinguished himself for being right more often than wrong about the U.S. economy and the equity market, a claim the majority of economists can’t make. The divergence between the Yardeni Fundamental Market Indicator and the performance of the S&P 500 since early October is not sustainable.
The gap between earnings and the S&P 500 will narrow, either due to an increase in earnings or a correction in the S&P 500. If earnings grow robustly in 2020 (+12% or more), the S&P 500’s multiple can be maintained and maybe modestly expand. However, if earnings only go up by 5% the odds would favor a contraction in the S&P 500’s multiple that could more than offset the increase in earnings. If S&P 500 earnings grow by 5% it is possible the S&P 500 ends 2020 down 5%, as that would merely bring its multiple down to 16.0. Since 2006 the S&P 500 has spent more time trading below a multiple of 16.0 than above it, and little time above 17.0, so a drop back to 16.0 seems more likely than a sustained move above 18.0.
For additional perspective consider this fact. Since 2002 the S&P 500 has only traded at a higher multiple in 17 out of 914 weeks (1.85% of the time), with 9 of those 16 weeks occurring at the end of 2017 and the first 4 weeks in January 2018. That stretch was followed by a two week intra-day correction of -11.8% that lowered the multiple from above 18.0 to 16.0.
Valuation isn’t the only challenge facing the stock market at the beginning of 2020. On Christmas Eve in 2018 CNN’s Fear & Greed Index was as low as it can go at +1. In contrast, the Index was in Extreme Greed territory at +91 on Christmas Eve in 2019. The turnaround in investor sentiment in 2019 has been remarkable, but represents a hurdle entering 2020 as it is a reflection of high expectations.
CNN’s Fear & Greed Index is not the only indicator showing that investor sentiment has become excessively bullish. The Weekly Investors Intelligence (II) survey recently recorded a bullish plurality of more than 40%, with Bulls at 57.7% versus Bears of just 17.3%. The American Association of Individual Investors (AAII) weekly tally showed 23.6% more Bull than Bears, the highest since January 2018.
The investors surveyed by Investor Intelligence and AAII are typically trend followers so by definition they become more bearish as the market declines and bullish as the trend higher persists. As such, extreme readings in the II and AAII surveys become a Contrarian Indicator. When these surveys show a large plurality of negative sentiment, the stock market is usually near a solid trading low.
In December 2018 the percent of Bears in the AAII survey exceeded Bulls by -28.0% and the II survey recorded -4.7% more Bears than Bulls. Both surveys reached levels comparable to February 2016, which was the most significant trading low in the stock market in the past 7 years.
Trend following and swings in investor sentiment are also evident in indicators that track pension funds, insurance companies, endowments, mutual funds, and other institutional investors. According to a recent analysis by RBC’s Futures Desk, using positioning data published by the U.S. Commodity Futures Trading Commission, institutional investors have established the largest net long position since 2006.
Equity index futures provide a vehicle for large institutional investors to increase or decrease their exposure to the U.S. stock market quickly. This is why their exposure can change so quickly. It was high in January 2018 as the S&P 500 made a new high, only to fall sharply when the S&P 500 dropped by more than -11.0% in February 2018. Exposure increased to a high level as the S&P 500 made a new high in September before getting squashed in December 2018. The current level is higher than it was in the summer of 2007.
Measures of sentiment are a reflection of what investors are doing with their money. As they become more bearish, they lower their exposure to the stock market by selling, and increase exposure when they find reasons to be more positive.
The current high level of bullishness suggests that investors have been piling into the market aggressively in recent weeks so the amount of sideline money has already been reduced. With money chasing stocks higher the market averages have become overbought with momentum indicators like RSI exceeding 80 on the Nasdaq Composite, Nasdaq 100, and S&P 500 which is rare. These averages are heavily weighted with mega cap stocks like Apple and Microsoft, which comprise 9.1% of the S&P 500. In 2019 Apple is up 84% and Microsoft 54% adding 5.7% to the S&P 500.
The market’s valuation is stretched, sentiment has become overly bullish, the market is historically over bought, and economic expectations are elevated. Investors will be focused on every piece of incoming economic data in the first quarter looking for confirmation that the anticipated acceleration in the U.S. and globally is on track. There are a number of reasons why investors may be a bit underwhelmed if data for the first quarter is weak. That could set the market up for a correction potentially before the end of the first quarter and certainly before mid year.
Since the tariffs on Chinese exports to the U.S. are paid by U.S. companies and not China, U.S. companies were incentivized to buy more inventory than needed prior to additional increases in existing tariffs or the potential imposition of new tariffs. One indication that this did occur is illustrated by the movement in 2019 in the Baltic Dry Index (BDI). The BDI is calculated daily by the Baltic Exchange located in London and is derived by averaging the shipping rates for 22 primary shipping routes around the world.
When the demand for shipped good increases the BDI trend higher and falls as demand and economic activity slows, making it a barometer of global economic growth. There is also a seasonal aspect since the BDI usually falls from May through August. After trade talks collapsed on May 3 and higher tariffs were threatened by President Trump, the BDI rose by 250% during the normally weak period from May through August.
Since its peak on September 4 the BDI has experienced its largest decline since 2009. If the BDI follows its seasonal pattern it should begin to rise during January through May which would confirm that the global economy is improving as expected. If the BDI fails to strengthen in the first quarter it would suggest expectations for a rebound are too optimistic.
The Inventory-to-Sales Ratio measures the relationship between sales growth and the level of inventories. When the Ratio is falling it indicates sales are growing faster and inventory is being pared, while an increase in the Ratio shows that inventories are piling up. When the Ratio is low and sales are good, companies increase their orders for goods which boosts production and GDP. If inventory levels are high, companies will wait until inventory levels are reduced before initiating orders for new inventory.
The Inventory Sales Ratio is high and near the highest levels since 2006. The increase during 2019 confirms that companies did front run the additional tariff costs by ordering more inventory than needed, and the slowing in the U.S. economy led domestic producers to also accumulate more inventory than needed. GDP was lifted in 2019 to the extent domestic firms increased production, but will likely soften in the first half of 2020 as inventory levels are worked off.
Coming into 2020 the consensus is that manufacturing has bottomed and will experience a Ushaped recovery. New Orders would turn up if the consensus expectation is correct. The manufacturing recession in 2019 certainly contributed to the increase in inventories as New Orders slumped during 2019 after peaking in February 2018. Manufacturing inventory levels are high and the six month average of New Orders is still falling, so there is no sign that a turnaround in manufacturing has even begun. That may develop soon but as yet the optimism regarding a manufacturing rebound appears premature.
As discussed in the December Macro Tides the 3.6% decrease in Capacity Utilization during 2019 is expected to delay a quick pickup in business investment, since the decrease wasn’t entirely due to trade friction:
“Business investment in the U.S. rose in 2017 and early 2018 in anticipation that global growth would remain robust and that U.S.’ firms would boost investment to take advantage of the tax breaks offered in the Tax Cuts and Jobs Act. The addition to production capacity and economic slowing has resulted in a significant drop in Capacity Utilization, which has fallen -3.6% from 79.6 in November 2018 to 76.7 in October 2019. Business investment is not likely to pick up until some of the increase in spare capacity is absorbed.”
It is a plus that Capacity Utilization ticked up to 77.3 in November from 76.7 in October shrinking excess capacity from 3.6% to 2.9%. If utilization continues to improve business investment may begin to grow by mid 2020.
The Federal Reserve’s Senior Loan officer survey quantifies banks’ willingness to lend and companies willingness to borrow. Bank lending standards have not been tightened which is a positive. Prior to the last three recessions, banks limited access to credit as economic growth slowed and then tightened further once a recession began.
Demand for bank credit, as measured by Commercial & Industrial (C&I) loans, remains quite weak as CEO confidence is low. If the economy and manufacturing had bottomed, demand for bank credit would be rising even if it was below 0. That has yet to happen which is another sign that the optimism about a rebound in the economy and manufacturing may be too optimistic and premature.
Boeing’s decision to halt production of the 737 Max in January could have a ripple effect on the 600 small to medium size businesses that are part of the Boeing’s supply chain. Although Boeing has said it won’t layoff any workers due to the production halt, some of the small companies that derive 50% or more of their sales from Boeing may not have that option. If production doesn’t restart before the end of the first quarter, GDP could be shaved by up to 0.4% on an annualized basis and unemployment claims could tick higher. The silver lining is that the lost GDP growth will be recovered over the balance of 2020 once the FAA gives Boeing its approval.
It was a surprise when the Labor Department reported that 260,000 jobs had been created in November, almost double what was forecast. There is a good chance that the labor market strength implied by the November report was over stated.
In the prior 9 months employers had been cutting hours for existing workers to lower labor costs and retain experienced workers. If the economy was improving it would be logical for employers to increase hours for existing workers, rather than hiring new employees. In November the average workweek for all employees on private nonfarm payrolls was unchanged at 34.4 hours, while the average workweek for private-sector production and nonsupervisory employees was flat at 33.5 hours. In manufacturing, the average workweek increased by 0.1 hour to 40.5 but overtime decreased by 0.1 hour to 3.1 hours.
Although the number of hours didn’t increase in November, wage growth continues to be healthy. This suggests the economy should continue to grow near or modestly above its long growth term trend of 1.9%.
Amazon was expected to hire 200,000 workers for its warehouses to pack boxes and deliver packages for this holiday season, up from 100,000 last year. Other retailers like Target and Kohl’s have also increased their hiring relative to last year as they expand fulfillment centers and staff in brick and mortar stores that allow consumers to order online but pickup their purchases in a store.
The Labor Department uses seasonal adjustments that utilize the past five years of data, so the sharp increase in seasonal hiring could have foiled the seasonal adjustment factor used for November. If the analysis of hours worked and seasonal hiring is on the mark, job growth will fall back to an average of 165,000 in the first quarter, which would be consistent with GDP growth of around 2.0%. This would represent decent growth but not the rebound the consensus is anticipating in U.S. GDP.
Despite the solid increase in wage growth, Retail Sales, (excluding automobiles, gasoline, building materials and food services), edged up 0.1% in November after rising by an unrevised 0.3% in October. Cyber Monday was in December this year which makes comparisons to last year uneven. However, retail sales growth has slowed markedly from mid 2018 and mid 2019.
My expectation was that the high level of consumer confidence would spur consumers to spend freely for the holidays. According to Mastercard, holiday retail sales increased 3.4% from 2018 (excluding auto sales). The Mastercard report details holiday shopping from November 1 through December 24, so it is unaffected by the fact that there were 6 fewer post Thanksgiving shopping days in 2019 compared to last year. Online sales were up 18.8% and represented 14.6% of total sales.
After enjoying a good Christmas and holiday season my guess is that consumers will take a breath and pay down their credit cards and increase savings in the first quarter.
In its third estimate of GDP for the third quarter, the Commerce Department reported GDP grew 2.1% as consumer spending rose 3.2%. Since consumer spending comprises almost 70% of GDP, consumer spending effectively accounted for all the growth in the third quarter.
Manufacturing represents just 11% of U.S. GDP. If consumer spending eases just a small amount in the first quarter it could easily wipe out all the gains to GDP from any improvement in manufacturing or business investment. This is one reason why I think the consensus could be too optimistic in expecting a U shaped recovery in the first quarter of 2020.
The Federal Reserve lowered the funds rate at three successive meetings starting on July 31 through October 30. Since it normally takes 6 to 9 months for changes in monetary policy to impact the real economy, the rate cuts won’t progressively kick in until the second quarter and beyond. The uncertainty surrounding the trade dispute between the U.S. and China and drag from imposed tariffs should diminish once the trade deal is signed. But the improvement in trade may not materialize in a meaningful way until the second half of 2020.
It is understandable that U.S. exports to China fell sharply as the trade war with China escalated, but U.S. exports to the rest of the world in dollar terms also plunged. This suggests it could take more time than expected for the export trade with China and the rest of the world to recover. All of these factors suggest there is a better chance that growth will disappoint in the first quarter and then potentially accelerate before mid year.
European Union
IHS Markit’s Eurozone Manufacturing PMI Index fell to 45.9 in December, the lowest level in 86 months and down from a 47.4 in November. IHS Markit’s Composite PMI combines manufacturing and services, and fell to 50.6 in December barely above 50.0, which denotes contraction or expansion.
The assessment by IHS Markit was decidedly downbeat:
“The Eurozone economy closes out 2019 mired in its worst spell since 2013, with businesses struggling against the headwinds of near-stagnant demand and gloomy prospects for the year ahead. The economy has been stuck in crawler gear for fourth straight months, with the PMI indicative of GDP growing at a quarterly rate of just 0.1%. There are scant signs of any imminent improvement. New order growth remains largely stalled and job creation has almost ground to a halt, down to its lowest for over five years as companies seek to reduce overheads in the weak trading environment and uncertain outlook. While service sector growth remains encouragingly resilient in the face of the manufacturing downturn, any further softening of the labour market could cause weakness to spill over.”
Fathom Consulting specializes in global financial and market research and produces an Economic Sentiment Indicator (ESI) that does a good job of tracking GDP in the major economies. Fathom tracks GDP on a quarterly basis so an increase of 0.2% translates to 0.8% annually. The ESI for the EU has yet to turn up so a rebound doesn’t look imminent.
Bank of America estimates GDP growth in the EU will be 1.0% in 2020 which would not represent much improvement from 2019. The rebound in global growth is not going to receive much of a lift from growth in the European Union.
Taper Tantrum European Style
The 10-year Treasury bond yield soared from 1.614% in early May 2013 to 2.984% in September 2013, after Fed Chair Ben Bernanke said the FOMC was thinking of scaling back the monthly amount of its QE program in testimony before the Joint Economic Committee of Congress on May 22
“If we see continued improvement and we have confidence that that’s going to be sustained then we could in the next few meetings … take a step down in our pace of purchases.”
Nothing had materially changed in the U.S. economy but the psychology and positioning of market participants was whipsawed by the speed and magnitude of the move higher in Treasury yields.
Globally, the amount of negative yielding sovereign bonds has fallen from $17 trillion in August to $11 trillion in December as global investors embraced the global recovery narrative. The ECB has been at the forefront of negative policy rates and lowered its policy rate to minus -0.50% in September. There has however been a growing backlash against the efficacy of negative rates since they haven’t boosted economic activity meaningfully, but have hurt savers and European banks as discussed in the November Macro Tides:
“A healthy banking system is the foundation of a modern economy but the negative interest policies of the ECB and BOJ have eviscerated Japanese and European banks. The ECB lowered its policy rate to 0.25% in December 2011 and 0% in June 2012, before going negative at -0.10% in June 2014. The Euro Stoxx bank Index has persistently underperformed the Euro Stoxx Index since 2010 and especially during the ECB’s low and negative policy rate regime since 2011. The decline in bank stocks in Japan and Europe make is very expensive for banks to fortify their balance sheets through the sale of equity. The inability to strengthen bank sheets will curb banks lending capacity, which is likely to impair economic growth in coming years. With bond yields below 0% in many countries, European banks simply can’t make much money making loans which is contributing to lackluster growth in the EU.”
As Deutsche Bank Chief Executive Officer Christian Sewing bluntly stated on September 4, 2019:
“In the long run, negative rates ruin the financial system.”
The anti-negative rate view is gaining traction since Sweden’s central bank raised its policy rate from -0.25% to 0.0% on December 19, after holding it below 0% for 5 years. Sweden’s Riksbank becomes the first central bank to reverse its negative rate policy, while policy rates remain negative in the Eurozone, Japan, Denmark, Switzerland and Hungary.
At its September 12 meeting the ECB announced it would begin buying $22 billion a month worth of securities on November 1 and continue its purchases as long as necessary for inflation to get back to its medium-term target of just under 2%. The ECB cut its forecasts for inflation over the next two and a half and now expects it to rise to only 1.5% by 2021, so it will be buying bonds for a long time. Mario Draghi also stated that members of the ECB believe it was time for a handoff from monetary policy being the primary driver of EU economic growth to fiscal policy when he noted that “there was unanimity that fiscal policy should become the main instrument“.
Draghi also called out Germany noting that a number of German research institutes were saying the country is already sliding into recession. For Draghi this indicated that Germany was “a case for timely and effective action.”
Christine Lagarde has taken over for Draghi at the ECB and shares his view that fiscal policy needs to become more stimulative within the EU and will undoubtedly pressure Germany to act.
There are a number of reasons why Germany will resist easing fiscal policy. Germany’s unemployment rate is 3.1%, less than half of the EU’s rate of 7.5%, so there is no justification for broad fiscal stimulus. The slowdown in Germany’s economy has been concentrated in trade which accounts for 47% of its GDP, and PMI manufacturing which represents 22% of GDP.
Easing fiscal policy is not going to address the drag from trade and the slowing in the global economy, or manufacturing which is closely tied to trade. It is part of Germany’s DNA to run fiscal surpluses and not deficits, so there is a natural built in resistance against running a deficit unless it is clearly necessary.
As 2020 unfolds the pressure on Germany, the Netherlands, and other countries to launch some amount of fiscal stimulus is going to build. It is also possible that as the sentiment against negative rates increases in 2020, there will be talk that the ECB may consider raising its policy rate from minus -0.50% to -0.40% or higher by early 2021. In 2013 Treasury yields soared not on any action by the Federal Reserve or sudden acceleration in U.S. GDP or inflation. All it took was the suggestion the Fed was considering reducing the amount of its monthly purchases.
The yield curve became negative in the U.S. in May 2019 not because the U.S. economy was entering a recession, but due to deeply negative bond yields around the world. The 10-year German Bund reached -0.71% on September 2 and has climbed to -0.19% as of December 30, an increase of 0.52%.
During the same period the 10-year Treasury bond yield climbed from 1.429% to 1.949%, an increase of 0.52%. Just as U.S. Treasury yields were pushed down by the decline in global bond yields, Treasury yields are being pulled higher as global yields rise. If the European bond market experiences its own Taper Tantrum in 2020, Treasury yields could increase significantly, even as the Federal Reserve keeps the funds rate unchanged.
Trade Deal
I didn’t expect the U.S. and China to agree to a Phase 1 deal so I was wrong and surprised. The binary aspect of this event was a challenge for me since the stock market moved higher in anticipation of a deal, while comments and actions by the Chinese and U.S. as negotiations evolved suggested it was a low probability outcome. Since the stock market was anticipating a deal, the downside risk of no deal outweighed the upside of a deal, as a failure would have resulted in an abrupt overnight decline that could have been substantial.
In terms of investing I am by nature conservative. I certainly did not expect the multiple of the S&P 500 to increase by more than 30% and account for all the gain in the S&P 500 in 2019 in an environment engulfed in uncertainty and concurrent decline in S&P 500 earnings.
Taken at face value the agreement appears to be good for the U.S., and if China lives up to its promises, it will be good. That of course is the rub with any deal involving China given China’s history. All one needs to do is look at how China has not abided by the World Trade Organization rules it agreed to when China was allowed to join the WTO in 2001.
Other than a vague outline there have been no details of the actual agreement, and probably won’t be until the deal is signed on January 15. A clear understanding and evaluation of the Phase 1 deal will not be possible for a long time. Here’s what we do know, which also explains some of the motivation for the Phase 1 deal:
- The U.S. agreed to suspend the December 15 tariffs on consumer goods, which would have hurt the U.S. more than China. China agreed to buy a significant amount of agricultural products including pork. China has been experiencing a swine flu epidemic that has wiped out more than 30% of its pig herds. As the Chinese middle class has grown in the past decade, the demand for protein has soared, which has been in part satisfied by the consumption of pork. The epidemic has caused pork prices to soar by more than 100% in the past year and resulted in a surge in food inflation, which is almost up 20%. Nothing upsets the average citizen more than a big increase in the cost of basic food. It was in China’s self interest to commit to buying as much pork as the U.S. can export.
- China will continue to pay a 25% tariff on $250 billion of imports. The only tariff roll back will be a reduction from 15% to 7.5% on $120 billion of imports saving U.S. businesses $9 billion a year. As of September 30 Nominal U.S. GDP was $21.5 trillion, so the tariff savings of $9 billion is a wisp and will not provide a lift to GDP. No details have been provided as to what actions by China would cause additional tariffs to be rolled back or increased if China doesn’t comply.
- Intellectual property rights were a key aspect of the trade negotiations and longer term more important than lowering the trade deficit with China. When the details of the Phase 1 trade deal are revealed, this is the area that will receive the greatest scrutiny, and could largely determine whether the deal really protects intellectual property rights of U.S. firms doing business in China or partnering with Chinese firms. It will be critical to learn how the Phase 1 deal addresses China’s new cyber security law that went into effect on December 1. The Multi-Level Protection law prohibits foreign companies from encrypting data so it can’t be accessed by the Chinese government. As explained by the China Law Blog:
“China’s 11 plan is to create a system that covers every form of network activity in China: Internet, mobile phone, WeChat type social networks, cloud systems, domestic and international email. China’s goal is not to create a commercial system where individual players can participate and make money. It’s goals are surveillance and control by the PRC government and the CCP. Confidential information housed on any server located in China is subject to being viewed and copied by China’s Ministry of Public Security and that information then becomes open to access by the entire PRC government system. But the PRC government is the shareholder of the State Owned Entities (SOEs) which are the key industries in China. The PRC government also essentially controls the key private companies in China such as Huawei and ZTE and more recently Alibaba and Tencent and many others.”
This means Chinese officials will be permitted, under Chinese law, to share seized information with state enterprises, which will enable them to weaponize the information against their foreign competitors. Access to the encryption keys will also enable China to penetrate the networks of firms located outside of China and steal data stored on foreign networks
In the 1990’s the U.S. was supportive of allowing China into the World Trade Organization hoping that integrating China into the global economy would not only increase wealth in China, but also make China more democratic and market oriented. After using the trade advantages provided by the WTO to become the second largest economy in the world, China has become less democratic and far more authoritarian. The fall of the Berlin Wall and the crushing of dissent in Tiananmen Square in 1989 provide a historic pivot, with the descent of one Communist country and the rise of another.
In an Orwellian twist China has in recent years turned the internet into an instrument of the state by using it to identify and track down dissidents. In recent years President Xi has purged any opposition through his crack down on corruption, and last year named himself President for life.
The new Multi-Level Protection law is an attempt to extend China’s reach well beyond its borders. The hardliners within China set a course years ago to reestablish China as the dominant nation in the world by 2049. That year holds great symbolism for the hardliners within the Communist Party, since 2049 is the 100th anniversary of the People’s Republic of China founding as a communist nation.
The Phase 1 trade deal at best is a temporary cease fire in what is likely to be a long drawn out struggle lasting years for global technological dominance.
China
Since China has grown significantly faster than the rest of the world, China has provided more than 30% of the increase in global growth in the past decade, even as growth has slowed since 2010. According to International Monetary Fund data, annual GDP growth has slipped in 7 of the past 8 years and is expected to continue to slow through 2024. The lack of annual volatility in China’s reported GDP suggests that China’s Communist Party not only ‘manages’ the economy but also the official GDP data.
A number of global research firms have reviewed various sub components of China’s economic data and have concluded that China’s official figures more often than not overstate GDP growth. For instance, Fathom Consulting has developed its China Momentum Indicator (CMI) which is designed to provide a more in-depth view of China’s economic growth. Fathom’s CMI is based on ten alternative indicators for economic activity including railway freight, electricity consumption, and the issuance of bank loans. By focusing on shadow measures of economic activity, rather than the data provided by China’s official number crunchers, Fathom believes the CMI is less prone to manipulation and is thus more accurate in measuring economic activity in China.
The fluctuation in Fathom’s CMI since 2002 looks far more representative of the type of volatility that happens normally as economic activity ebbs and rebounds over time, compared to the smooth and stable change in China’s official GDP. Since peaking in late 2017 Fathom’s CMI has been trending lower and is suggesting GDP growth is closer to 4.1% than China’s official rate of 6.0%. More importantly, the CMI offers no evidence that China’s economy is about to strengthen.
This conclusion is further supported by the weak growth in the China Credit Impulse. The rebound since the fourth quarter of 2018 looks anemic when compared to prior surges in credit. While the Phase 1 trade deal should be a positive for growth in China, the impact is not going to materialize in the first quarter of 2020 and may not really come into play until the second half of 2020.
Global Equity Markets
Stock markets around the world have rallied strongly since August after investors realized the risk of a recession was over blown and central banks responded as if the global economy was on the brink of a crisis.
The resolution of the Trade War between the U.S. and China has raised expectations that the recession in global manufacturing has ended and will be followed by a quick rebound in global trade, manufacturing, and business investment.
The timing of this outcome is what could become challenged in early 2020, since most indicators suggest investors may be overly optimistic. There is a huge disconnect between the S&P 500 and a composite of U.S. PMI’s that could leave equity prices vulnerable to a setback in the first half of 2020 if not the first quarter. If the S&P 500 corrects, global equities will follow.
S&P 500
The S&P 500 has rallied since the low on October 7 without taking a breath. Markets are a reflection of human behavior and the normal process is to inhale and then exhale, so the recent behavior is simply not normal. The S&P 500 has become overbought and sentiment is universally bullish.
The S&P 500 will be vulnerable to at least a modest correction in the first part of January. With bullish sentiment so widespread and momentum strong, the initial pullback is likely to be shallow as investors buy the dip. A better feel for how the S&P 500 will trade in the first quarter won’t really be possible until we see how it rebounds after any setback. Initial support should be the red trend from the February 2016 low near 3170.
The more significant level of support is the December 3 low at 3070. If and when 3070 is tested, how the S&P 500 reacts will reveal much about what to expect in coming months.
New Decade Big Changes in Store
The coming decade is the culmination of the 80 year cycle that has marked significant turning points in our nation’s history i.e. 1781, 1861, 1941, and potentially 2021. Each of the prior turning point decades included major changes and upheaval, so we should be prepared.
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