The global economic environment seems to be healthier than it was a year ago. Notably, we see evidence of more solid growth around the world, and not just in the U.S. as was the case through much of 2018. The consumer sector in particular has been quite strong and has propelled the broader economy.
One year ago, investors were highly worried about a global recession, but those risks appear to have faded. In fact, if anything, we think investors may have grown too optimistic over prospects for stronger growth, as reflected by rising stock prices. We think risks remain, especially regarding the manufacturing sector and global trade levels. We don’t think it will happen, but weak manufacturing and trade could act as a drag and significantly slow down global economic momentum. We think it is more likely that the strong consumer and service sectors could help provide a lift to manufacturing data. But so far evidence of that scenario has been scant.
Trade woes represent a significant risk. The main culprit behind any economic weakness continues to be the rise in protectionism and broad trade policy uncertainty. Trade issues have clearly hurt global manufacturing levels, caused a downshift in business sentiment and depressed capital expenditure spending. If protectionism persists and new tariffs continue to be enacted, this damage could deepen.
We see some glimmers of hope, however. While the latest rounds of negotiations over the U.S./China phase one trade deal have stalled, we think prospects remain for a limited agreement and new tariffs could likely be delayed. Even as tariffs have been in place and as economic data from the eurozone has been spotty, Chinese export levels have been picking up, which is a critically important indicator of broader global trade levels. It is too early to say whether this improvement is a harbinger of better things to come, but it is clearly an optimistic signal.
At present, equity prices reflect a better trade environment, and we hope those signals are correct. A reduction in tariff levels (or even an easing in trade tensions and more clarity around future policy) would be bullish for stocks. If corporate management teams had a better sense of where trade issues were heading, they would be more willing to invest in their businesses, which would be a positive for corporate earnings and profits.
Monetary policy may have run out of steam. Part of the reason we have a cautious outlook toward the economy and global financial markets is that monetary policy may have exhausted its ability to provide a tailwind for stocks. Global monetary policy remains extremely accommodative, but central banks, including the Federal Reserve, now appear in a holding pattern.
The drop in interest rates over the course of 2019 has been a positive for stock markets. But at this point, we have a hard time seeing additional cuts without also seeing notable economic weakness. And such weakness would be a negative for stocks and would probably outweigh any additional benefits arising from even lower rates.
In contrast, if economic growth does pick up (perhaps due to better news on the trade front), policymakers will come under increasing pressure to once again raise interest rates. We don’t see that happening in the near term given how cautious central bankers have been, but monetary policy is less clear now than it was earlier in the year.
This is particularly true given the current monetary policy backdrop. Conditions remain extremely accommodative and equity friendly, but the Federal Reserve seems unlikely to push interest rates any lower, unless it sees fresh evidence of economic weakness. And such evidence would be a bearish sign for stocks.
We remain mildly constructive toward stocks. We are hopeful that a modest improvement in economic growth will take hold, and we see prospects for better trade conditions from here. A slow recovery in manufacturing and trade would probably cause interest rates to rise modestly, but not to the point that rising rates would damage equity markets. At the same time, corporate profits could grind slowly higher in 2020. All told, such an environment causes us to be mildly constructive toward stocks.
The risks, however, appear skewed to the downside. The problem is those risks are more about political issues and policy decisions rather than economic fundamentals. Politics and policy mistakes are much harder to handicap than issues such as economic weakness or credit fundamentals, making them particularly tough to plan for.
Additionally, we think that valuations for equities and other risk assets have gotten full over the past few months. At this point, most of the good news appears already baked into prices. That means that economic growth and trade clarity will need to deliver in order for prices to continue moving higher.
Source: Bob Doll, Nuveen
Chart reflects price changes, not total return. Because it does not include dividends or splits, it should not be used to benchmark performance of specific investments.
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