At the end of 2017, markets and the economy appeared to have few worries, and things looked very optimistic. Equity markets globally had strong returns and one of the least volatile periods in history (the S&P and MSCI All Country World Index (ACWI) made it through the entirety of 2017 without a 3% correction from a prior peak).
Economic data was improving around the globe, as the JPMorgan Global Manufacturing PMI reached the highest level since February 2011 and gradually increased throughout the last six months of 2017.
However, 2018 has been a different story. The S&P 500 has experienced seven 3% corrections and two 10% corrections. It is also currently trading below its 200-day moving average and below the prior peak set on September 20th.
The MSCI ACWI experienced a 10% correction in January and has not returned to a prior peak.
Through November, the JPMorgan Global Manufacturing PMI has declined every month except for April.
As we head into 2019, one of the major macro items we are trying to decipher is whether this is another global economic slowdown, like 2011 and 2015-2016, or if the U.S. is going to enter a recession. At the current moment, the data in the U.S. is still very strong and is not showing signs of recession risk in the next twelve months. Leading economic indicators are still increasing, while consumer confidence has pulled back from peak levels but is still very high. The yield curve has continued to flatten although the only inversion has been a slight difference between the two- and five-year Treasury. Even still, there is usually a lag time of several months between an inversion and the start of a recession.
So far, the weakness in economic data has been concentrated in the more interest rate sensitive and early cycle sectors of the economy like housing and auto stocks. If economic data starts to weaken within mid and late cycle areas, like consumer spending, consumer credit, and employment, this would indicate that 2020 is more likely to be the start of a recessionary period for the U.S. as opposed to the bottom of another economic slowdown within a secular growth environment.
Risk assets (equity markets and high yield) have been pricing in a deceleration in economic activity and expected profit growth in 2019. This is likely to persist into the first part of 2019 and could lead to a continued increase in volatility. Another potential factor contributing to the increased volatility experienced during 2018 is the shift in monetary policy. Global central bank balance sheet assets as a percent of GDP have declined throughout 2018.
This has been led by the U.S. Federal Reserve, as their balance sheet assets as a percent of GDP have declined from over 25% to just under 20%.
Another notable change has been the directional move in global central bank interest rates. For the first time since early 2011, over 50% of the most recent central bank interest moves have been hikes, and this trend is likely to continue as the ECB follows their current guidance and starts to increase interest rates in the second half of 2019.
We will continue to monitor the economic data to determine if higher interest rates, tightening financials conditions, and weaker economic activity overseas are going to push the U.S. into a recession. If this is another cyclical slowdown within a continuing secular growth period, the recent weakness in risk assets is likely to provide attractive buying opportunities during 2019.
Rank Dawson, CFA
Vice President, Strategic Planning
Boyd Watterson Asset Management, LLC
The views expressed herein are presented for informational purposes only and are not intended as a recommendation to invest in any particular asset class or security or as a promise of future performance.