In January, the equities markets bounced from significantly oversold conditions at the end of December, on the hopes that a) the Fed stopped it tightening cycle in time, and b) the halt to the government shut-down occurred in time to avoid negative Q1 GDP growth. As I have stated in prior blogs, “hope” is not a good investment strategy. But wait! The “hope” regarding the Fed doesn’t even make sense. Shouldn’t investors be concerned about the reason why the Fed, and now other major central banks, especially the Peoples’ Bank of China (PBOC), have turned dovish? If the central banks are concerned about future economic growth, as they are in China, Europe, Japan, and now in the U.S., or worried about the lagged impacts of their previous policy tightening moves, as they are at the Fed, then investors should be concerned and worried, not ebullient. Looking back at history, the time to be investing is when the Fed makes its last easing move, not when they are just starting to ease, or in the Fed’s case, calling a halt to further tightening.
The world is not coming to an end, and it is doubtful that the next recession will inflict anywhere near the pain that the last one did. But, that doesn’t mean investors should play ostrich and bury their heads in the sand. Some of the world’s economic leaders interviewed at Davos told us that the immediate future just holds a slowdown, not a recession. I can’t figure out how they know this. In any event, those remarks fight the odds and history:
• 80% of the time the Fed enters a tightening cycle, a recession results;
• 80% of the time we get an inversion in the 2-year/5-year yield spread, there is a recession;
• According to Wells Fargo analysts, 67% of the time there is a stock market correction, a recession results.
World Economies Are Rapidly Decelerating
The chart patterns are stunning, and for some critical data, the relevant phrase would be “falling off a cliff.”
In China, there are very significant issues. In 2018, the PBOC cut bank reserve requirements four times. In the past, this worked to spur loan growth and keep the economy buoyed. But, not this time, as there is simply too much debt (see “China Risks a Very Hard Landing,”, WSJ, January 24, p. B12). The PBOC is now contemplating even more easing. Further, while the 6.4% official GDP Q4 growth is the weakest in three decades, other data leave analysts questioning whether there is any growth there at all. Consumption growth is stagnating; auto sales in 2018 were lower than in 2017; the import/export data are also quite weak.
The Bank of Japan (BOJ) cut its official inflation forecast for 2019 from 1.4% to 0.9% in recognition that demand is waning. Japan, together with their Asian brethren, reported a contraction of -3.8% in exports vs. a year earlier. The latest Markit PMI manufacturing survey put Japan at 50.0, right on the cusp between growth and contraction, i.e., at “stagnation.” Worse, the new order, production, and new export sub-indexes were all in contraction territory.
In Europe, things are only getting worse. Italy is surely in recession. Greece, Switzerland, and Lithuania all had negative Q3 GDP growth. France, with the yellow vest protests, also appears on the cusp. And the Brexit issues have the potential to significantly disrupt both the UK and EU in terms of trade. Markit’s Composite PMI for the EU was 50.7 in January, down from 51.1 in December, and at a 5.5 year low. The new orders sub-index, at 49.3, shows contraction.
Emerging US Data
Even in the US, some of the data charts look like “Niagara Falls.” Investors should be aware, it isn’t the level of the indexes, but their direction and the magnitude of the changes that are most important. Some examples: The Philly Fed’s Non-Manufacturing Index was +35.5 in November and +1.0 in January. The Richmond Fed’s New Manufacturing Orders sub-index was +34 in September and -11 in January, with Order Backlogs registering -21. The magnitude of these changes is unusually large.
The US’s housing data indicates recession in that sector. Existing Home Sales, whose high this cycle was equal to the low of the dot.com bust, fell -6.4% in December from November and was -10.3% lower vs. a year earlier. The momentum in this sector is clearly negative.
The U.S. Consumer Sentiment Index also looks like it fell off the counter with a 90.7 January reading vs. 98.3 in December, the largest drop since 2011. That survey also revealed weakness in auto, home and appliance buying intentions.
Reiterating, what we saw in January in the equities market was a bounce from a significantly oversold condition, the worst December since 1931. December’s market swoon wasn’t so much based on fundamentals, although they were already deteriorating, as on the market throwing perhaps the biggest tantrum in its history over Fed policy. Markets were worried about the Fed’s “forward guidance;” that it intended to continue its tightening cycle. Yes, even in the face of weakening data. The Fed did blink in January; guided toward a “pause” in rate hikes, and now revealing its intent to reconsider the speed of balance sheet runoff and its ultimate level. But, these are moves toward “neutral,” not “ease.”
The Fed Moves to Neutral
The language in the Beige Book and in December’s Fed minutes is more characteristic of a Fed in easing mode than neutral or tightening. A Fed watcher, like myself, reading those documents without the pre-knowledge of the policy decision, would have concluded that the policy prescription at the meeting’s end was an easing one. So, my earlier blogs indicating that the December policy tightening was a message to the White House to “back off,” i.e., an assertion of its independence, appears to be not only plausible, but likely, given the minutes and the new forward guidance that “pause,” and “flexible” are the currently operative words. The newest discussion regarding the appropriate level of the balance sheet run-off is just more evidence that the Fed has changed its view that robust economic growth can occur if policy is further tightened. The January 30th Fed statement indicated a concern with global economic deceleration and said the Fed would be patient when it comes to further increases in the Fed Funds rate (again, a move toward neutral, not ease).
As indicated above, investors should be much more concerned that the Fed no longer sees “solid” growth than joyous over such revelations. My final observation is that longer-term interest rates have refused to rise in the face of rising January stock prices. If things were that solid and a recession had low odds, rates would be rising.
Investors should remain cautious. While a recession is not a certainty, history tells us that the odds of one are high.
Robert Barone, Ph.D.
Robert Barone, Ph.D. is a Georgetown educated economist. He is a financial advisor at Fieldstone Financial. www.FieldstoneFinancial.com .
He is nationally known for his writings and Robert’s storied career includes his having served as a Professor of Finance, a community bank CEO and a Director and Chairman of the Federal Home Loan Bank of San Francisco. Robert is currently a Director of CSAA Insurance Company (a AAA company) where he chairs the Finance and Investment Committee. Robert leads the investment governance program at Fieldstone Financial, is the head of Fieldstone Research www.FieldstoneResearch.com, and is co-portfolio manager of the Fieldstone Financial Unconstrained Medium-Term Fixed Income ETF (FFIU).
Statistics and other information have been compiled from various sources. The facts and information are believed to be accurate and credible, but there is no guarantee as to the complete accuracy of this information.