Is Global Growth Crumbling?
It was just three months ago that stock-market investors were being swept up by a euphoria pinned to the idea of economic expansion taking hold harmoniously across the globe—a dynamic that hadn’t occurred since the 1980s, and one that was expected to extend into 2018.What should investors do? The first thing they should do is read my recent comment on why it's the end of days for markets.
However, less than midway through the year and some market participants are already spotting cracks in the notion of so-called synchronized global growth, with some fearing that a whiff of stagflation is starting to permeate. Stagflation is typically described as persistently high inflation and high unemployment, combined with weak economic demand.
Perhaps it is that worry of a slowdown that has so far overshadowed a run of solid results from some of the most highly valued and most influential U.S. corporations, including Amazon.com Inc. (AMZN) and Facebook Inc. (FB) said Alec Young, managing director of global markets research at FTSE Russell.
Indeed, about half the S&P 500 companies have reported first-quarter results during the busiest week of the season of quarterly results, with the earnings growth rate at 22.9%, compared with 18.3% at the end of last week and the 11.3% expected at the start of the quarter, according to FactSet data. Moreover, approximately 80% of those companies reporting results surpassed analysts’ earnings estimates, better than the 74% four-quarter average. And earnings outperformance was substantial, with companies surpassing average estimates by 9.4%, above the average of 5.1%.
That is the sort of performance that should have elicited cheers on Wall Street. Instead, the Dow Jones Industrial Average (DIA) put in a weekly decline of 0.6%, the Nasdaq Composite Index (QQQ) lost 0.4%, and the S&P 500 index (SPY) closed virtually unchanged for the five-session stretch.
What gives?
“The problem is that there have been macro forces that have been clouding the outlook, so it’s preventing the investor from taking the good earnings news and running with it,” Young told MarketWatch.
Some of those macro forces include a deceleration in places like the U.K., where the economy grew at the slowest pace in more than five years in the first quarter of 2018, according to a report from the Office for National Statistics on Friday.
It may be that type of retreat that gave European Central Bank President Mario Draghi a degree of pause during his news conference on Thursday as he discussed the eurozone’s monetary-policy path and the timing of the phaseout of the ECB’s crisis-era €30 billion ($36.6 billion)-a-month bond-buying program.
Last year, the eurozone grew at the fastest pace in a about a decade, bolstered by expansion in France—a showing that outstripped that of the U.S. However, industrial output in February, fell by 1.6% in Germany, the eurozone’s largest economy. That slide came as overall business activity in Europe had begun to lag amid persistent concerns of the imposition of tariffs by President Trump’s administration on billions of goods to the U.S.
In Asia, Bank of Japan Gov. Haruhiko Kuroda said that the central bank was dropping its effort to predict when inflation would hit its 2% target, implying that the BOJ, is uneasy and believes that it still has work to do to normalize its easy-money policies.
Against that backdrop, inflation has been percolating, with commodities, particularly West Texas Intermediate crude-oil future gaining sharply in recent weeks. WTI, the U.S. oil benchmark, has risen 12.5% so far this year, with more than 5% of that advance coming in just the past 30 days.
That rise in commodities translates into higher costs for corporations and consumers alike, higher costs that may be tough to swallow amid any genuine signs of pullback in economic expansion in its ninth year in the U.S.
Thus far, signs of inflation, or rising prices, running out of control after a period of dormancy are modest, however. But it is worth watching in the context of stagflation, said Young.
“While the recent downtick in growth coupled with the uptick in various inflation indicators from wages to commodity prices, has been relatively modest, investors are now more open to the risk of stagflation than previously,” he said.
“That said, recent data is more accurately characterized as a hint of stagflation rather than anything more acute and, therefore, it shouldn’t be a surprise that many of the economic metrics that have characterized periods of more pronounced stagflation historically, such as unemployment, still remain low,” he added.
Indeed, the unemployment rate for March, clung to a 17-year low of 4.1% and is expected to go even lower, according to economists. So, it may take a seismic downtrend in the state of the jobs market for the other criteria of stagflation to be met: high unemployment.
Economic growth in the U.S. has tapered a tad, with the first-quarter gross domestic product, the official scorecard for the economy, coming in at the slowest pace in a year owing to a big pullback in consumer spending. Still. the economy held up better than expected and the first reading tends to be seasonally weaker.
Of course, not everyone is wringing their hands over an economic slowdown or inflation.
In fact, Torsten Sløk, Deutsche Bank’s chief international economist, told MarketWatch that the real threat to markets may be the economy overheating: “There are certainly upside risks to inflation, but I think it is too early to call for a slowdown in growth. The consensus expects solid growth for 2018 and 2019.”
See also the top line in the table below, which shows consensus expectations to U.S. GDP growth and other economic variables (click on image):
Sløk said that, in his view, “The bottom line is that the biggest risk today is not recession or stagflation but rather overheating.”
What should an investor do in the face of all this?
“We are living in this time of great news and focusing on the possibility of future headwinds,” said Art Hogan, chief market strategist at B. Riley FBR Inc. “It’s a marked change from when everything was rosy,” he said, referring to last year’s market resilience. “I could punch you in the nose and you could say ‘That’s going to be good for earnings.’”
Hogan’s advice is to clients: “Don’t listen to some of the noise, a lot of that is going to resolve itself.”
There, I discuss why we're at an important inflection point in markets where you have peak earnings which typically coincide with peak coincident economic indicators at a time when short rates are rising and the Fed is still intent on raising rates despite the flatter yield curve signaling a slowdown ahead.
I also told you to pay attention to the US dollar (UUP) which has been surging lately, signaling an important change of trend is underway (click on image):
As you can see, the USD ETF crossed above its 200-day moving average which is why I'm not in the camp that the rise in oil prices and commodities, in general, is sustainable.
Moreover, if my prediction comes true and the US dollar rallies over the next couple of years, it means import prices will decline too. Lower commodity prices and lower import prices means lower inflation expectations ahead which is bullish for US long bonds (TLT).
I still maintain US long bonds are a great hedge for downside risks and will offer the best risk-adjusted returns going forward (click on image):
I emphasize risk-adjusted returns because you can make more money elsewhere but only by taking a lot more risk.
Now, typically we only see the US dollar rally when US long bonds sell off (yields go higher) but I think we're headed toward a global economic slowdown, coupled with fear in markets, which is bullish for both the US dollar and US long bonds.
Importantly, the reason why the US dollar and US long bonds are rallying is global PMIs have rolled over and are decelerating, which augurs well for both.
And if we get a crisis in the summer or fall, it will only reinforce these trends. The greenback will rally sharply (along with the yen and Swiss franc) and US Treasuries will rally because of the flight to quality.
We're not there yet so don't panic just yet. There is still plenty of liquidity to drive risk assets higher, the Fed might pause and wait to see before hiking rates in June (doubt it).
The problem right now is people are way too focused on coincident economic indicators (employment, inflation), totally ignoring that leading indicators (like the S&P, ISM New Orders Index, etc) are signaling a slowdown ahead.
And it's not just global growth I'm worried about. Even in the US, there are serious doubts consumer spending will drive growth going forward. Also, if gas prices keep creeping up, they will negate the effects of Trump's tax cuts which is why I don't see oil prices rising further and staying at elevated levels. All this will do is reinforce deflationary headwinds down the road.
You will hear a lot of theories about why oil prices will trend higher, like "global demand is strong as the global economy is booming" and "supply constraints are kicking in as OPEC is curbing output".
The problem? Global demand isn't strong which is why the US dollar is rallying and there's a limit to how much OPEC can cut output without shooting itself in the foot, especially if prices rise too fast, too high and create a global shock which is led by a deflationary bust.
When it comes to oil prices, I see a lot of people making big proclamations but very few are thinking things through. The same thing with US long bonds, very few market pundits recognized the backup in yields so far is all part of what I call the bond teddy bear market.
Can the yield on the 10-year US Treasury surpass 3% again and even hit 4%? It might pass 3% again but there's no way it will see 4% now that global growth is crumbling. And if it does, back up the truck, leverage to the max, and buy US long bonds.
Anyway, take the time to read my recent comment on end of days for markets where I go into a lot more detail on where you should be investing.
Institutional investors who subscribe to Cornerstone Macro's research should absolutely watch Francois Trahan's presentation, Economic Exuberance Meets Market Volatility. It's beyond excellent research which you simply won't find elsewhere.
Below, former Dallas Fed advisor Danielle DiMartino Booth and Stifel Nicolaus chief economist Lindsey Piegza on how the economy is impacting the stock market and whether the Federal Reserve will raise interest rates.
This is a very interesting discussion by two top female economists (the men are stale, boring and not as good explaining their views). I commented on LinkedIN:
I doubt this is a sustained pickup in wages. More importantly, did anyone watch Good Morning America this morning? Gas prices are starting to bite consumers, and if they keep creeping up, they will negate Trump’s tax cuts for most Americans (the ultra rich don’t care).And legendary investor Mark Mobius tells you why the US dollar likely to continue strengthening and why he fears a substantial correction is possible.
Stay tuned but I'm pretty sure global growth is crumbling so stay US-centric, stay defensive in stocks and for Pete's sake, hedge your downside risks in your portfolio by allocating to good old boring US long bonds. When the economic slowdown is in full throttle and these boom boom markets get clobbered, you won't sustain massive losses.
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