By: Guy Adami, Director, Advisor Advocacy
Published May 1, 2019
In April’s Market Update Call, Guy Adami and three guest panelists cover a number of topics from the current situation with China to the biggest risks facing the market for the second half of 2019. They also briefly touch on Brexit and the flattening yield curve. Our three panelists weighing in on the updates this month include Alicia Levine, Chief Strategist at BNY Mellon Investment Management; Richard Lawrence, Senior Vice President Portfolio Management at Brandywine Global; and Eric Winograd, Senior Economist Fixed Income at Alliance Bernstein.
What Market is Correct in Signaling?
Guy Adami’s first question was about market signals. He asked Alicia which market is right in terms of signals – equity or bond? Alicia responded that for the most part, there is clearly a divergence in the message. The bond market says growth is slow, while equity markets are closing in at all-time highs. She feels the equity market is correct because there’s been a bottoming both in global data and in the earning trough in the first quarter, and they’re beginning to see green shoots on the earning side and in the global data. This is a signal that the weakness the market was scared about in the 4th quarter, and that the data confirmed in January and February, is turning. We are near healthy valuations, and we are positive on the market going forward.
Guy also referenced Larry Fink’s comments that the biggest risk to the market is a potential swing to the upside. He asked Alicia if she thought the market was ignoring that risk. Alicia mentioned investors are underinvested on both the institutional and the retail side with high allocations to cash, and this is a sign that the market has made people nervous. As long as the fundamentals pull together, you can move higher. The real question is what is going to move the multiple up.
U.S. and China Relations: A Trade Deal
Moving onto the trade deal with China, Guy asked Eric for his opinion on what happens next in the scenario that a trade deal goes through, as most people expect will occur. Eric mentions a challenging environment because of implementation and enforcement. It is a forward-looking political process. Even if a deal is agreed to and signed, the relationship with China will most likely remain contentious. He cites recent examples such as the new free trade agreement between the U.S., Canada and Mexico (still hasn’t been ratified legislatively) and even the recent deal with North Korea (they tested a missile recently). Just because a deal is signed doesn’t mean the conflict melts away. Is he surprised that the market is as complacent as it is? Even though we are a percent and a quarter in the S&P from being at an all-time high, Eric says another perspective is that the market has been flat over the last six months. It doesn’t seem as though the trade war will escalate; the data has held up relatively well. At the end of the day, it’s the underlying economy that matters, and it still looks pretty good, at least here in the U.S.
Continuing the discussion about China, Guy referenced August of 2015-2016 when China devalued the yuan, and the S&P dropped to about 1810. He asks Richard how the easing we are seeing in China with the policies in place today differs from that period? Richard says there’s no doubt we’re seeing a meaningful level of stimulus going into the Chinese economy. The most significant aspect of the stimulus this time around is that the Chinese seem to be targeting it more at the small and medium enterprises. They’re doing it through targeted tax cuts into the corporate sector and individual sector. What he thinks we’ll see is more of a stabilization of growth rather than the sharp rebound of 2016. This is a much more sustainable form of stimulus, and very consistent with the “lower for longer” schematic we’ve heard talked about in traditional markets as well. This should help to elongate the global business cycle in all the major economies.
Guy’s follow up question was how much of the situation in China is driven by the domestic fiscal monetary policy easing vs. trade negotiations? Their markets have come ratcheting back in a major way. Richard would attribute both of those factors to the weakness we’ve seen in the Chinese market. The weakness in the market you could probably attribute 50/50 to both these factors; while the weakness in the economy was driven more by the deleveraging in the banking system. Now we are starting to see a reversal of that stimulus trend, and that’s the part that looks to us more interesting. The trade deal is sort of largely priced in at this point, and the upside from here is more about what’s happening in terms of the incremental stimulus.
Tariffs Work: A Risk
Guy asked Alicia for her opinion on the biggest risk to the market right now that could derail everything. The biggest risk she sees is that the current administration has essentially learned that tariffs work. They work particularly if you’re a relatively closed economy as the U.S. is, and the partner that you’re targeting is dependent on global trade and external demand. She is thinking about Europe and her biggest fear or concern for the market is those 232 tariffs. She has some concern that the lesson learned with China is that tariffs work, and if you want a trade deal you have to inflict a little pain. This would be very detrimental to global markets if it happened, and she doesn’t think it’s a 0% probability. There does seem to be evidence of a recovery in China, and you can see it in all kinds of different sectors – but we’d like to see that feed into stabilization in Europe.
Eric was asked what role, if any, has the trade dispute meant in terms of monetary policy in the U.S.? In his opinion, the impact of the trade war has not been very large on the U.S. economy, a relatively closed economy where it is hard to make the math work with the tariffs for a meaningful impact. Where it has mattered is the impact it has had on our trading partners, for example in Europe, where a weakness in the global economy has been an impediment to the U.S. expansion. The Fed phrases it as a headwind: it is a restraint on growth but doesn’t stop the U.S. economy. That has certainly impacted the Fed’s pivot from talking about raising rates and now changing their stance even through 2020. The biggest risk to the global economy is a European recession, and if it happens, it would be because the administration in the U.S. decides to start a trade war with Europe. Their economy is too fragile to handle that right now.
Brexit & Yield Curve
Does Brexit have any market impact? Richard says not directly, given the fact that the risk of a hard Brexit has diminished. He suggests we are probably heading towards a softer Brexit with a revised deal and is more concerned about the longer-term impact on the UK economy citing the decline of business investment and foreign investment flows.
What about the flattening yield curve or one that could invert? Eric says this signal of the flattening yield curve is exaggerated; the longer end of the U.S. curve functions as something of a global rate right now. If you look at the holdings of the central banks around the world of fixed income securities, it’s no surprise that yields are a lot lower than they might be otherwise based on where we are cyclically. He says it is just important to cross check it with incoming economic data. When we do that in the U.S., it doesn’t look from the data that there is any reason to be concerned about a recession.
Richard agrees with Eric, stating we’ve got a lot of secular disinflationary influences that are likely to keep long rates permanently lower including the aging demographic, debt load, technology, globalization, etc. Because of those influences, the signal value of the yield curve has diminished. But, he says a sustained inversion is the bond market sending the central bank a very clear signal that monetary policy is too tight. This played out over the last three months with that inversion occurring, and it’s no longer there because the central bank has gotten the message and made a clear shift. In this case, it worked as an effective signal.
Alicia also weighs in saying there is a sense that the bond market was forcing the hand of the Fed. You can’t ignore the signal, but she thinks the market is wrong to expect a cut this year since we’ve already gotten a tapering of quantitative tightening which will be over sooner than expected.
Final Thoughts from Panelists
Eric Winograd: The global and U.S. economies are a little slower this year. It is important not to overreact; a slow down is sometimes just a slow down and not a collapse. The yield curve can tell you things are slowing, but the data and economy are holding up in the U.S. There are signs of progress and improvement.
Richard Lawrence: We would characterize what we think we’re heading towards is a “synchronized global soft landing.” The stimulus in China benefits emerging markets and could ultimately provide stabilization in Europe. As a result of that with the Fed on hold and the fiscal thrust gone, we are thinking the dollar’s going to be a weaker, not stronger, currency this year, so we have a big dollar underweight on our investment strategies across the board.
Alicia Levine: We see the U.S. powering global growth this year even at a slower pace. We see a rebound from the first quarter both globally and in the U.S., but we also see a weaker dollar in the second half. An interesting market to look at is the European market; it is worth looking at if you think green shoots are happening in China, Asia, and emerging markets.