July 2019 - Market Research and Commentary

In the wake of trade tension and recent tariffs, global markets have been in a state of limbo. In both debt and equity markets, different indicators have given investors mixed signals about the state of the global economy. These mixed signals, in conjunction with the China-U.S. trade conflict and other geopolitical tensions that we discussed in our June newsletter, have left global markets in an uncertain state as summer begins.

Chart I - Thinning Spread

Chart I - Thinning Spread

Mixed signals are particularly profound in the fixed income and corporate bonds market. Throughout the beginning of June, a resurgence in corporate bonds renewed investor confidence. This claim is supported by the narrow spread that exists for both speculative-grade and investment-grade bonds since the beginning of the year to today. The extra yield that investors demanded from corporate bonds over Treasury yields was around 1.26% in the middle of June. This narrow spread is an indicator of investor confidence and is a positive signal for the overall strength of the bond market and the U.S. economy. It could also be a change in investing strategies as a result of fewer interest rate increases for 2019. Or said another way, as investors changed their strategies following what appeared to be a steadily increasing interest rate path, they now have to adjust and accept that a cut is now the most likely direction.

Despite these reassuring figures, over the past month there was a sharp decline of the 10-year Treasury yield below that of the three-month yield. This inversion of the yield curve muddies the waters of the fixed income market and brings into question the overall health of the global economy as we head into the summer. Despite a resurgence in corporate bonds that is renewing overall investor confidence, these narrow spreads come in tandem with mixed messages on risk in markets around the world.

Chart II - 10-Year Yield now at 2%

Chart II - 10-Year Yield now at 2%

As it relates to fixed income, Treasury yields are at near-record lows yet capital inflows into riskier ETFs and mutual funds that invest in speculative and junk-grade bonds have seen a $1.7 billion inflow through the middle of June. This is even more notable once the last two months of the bond market are considered in which there were $7 billion in net cash outflow from these speculative bonds. This reversal is peculiar and only adds to the general market confusion and conflicting signals throughout. 

Chart III - Morgan Stanley Business Conditions Index

Chart III - Morgan Stanley Business Conditions Index

These mixed signals in the bond markets are echoed in the equities markets, with many institutions making preparations for a recession. Morgan Stanley’s Chief Equity Strategist recently cited a number of factors that signal the global economy is on the verge of a recession. Morgan Stanley stated, “data points and analyst sentiment are falling and we think PMIs and earnings revisions are next.” Some specific points of concern Morgan Stanley cited for benchmarking the overall health of the economy were declining oil demand and the largest one-month drop in the Morgan Stanley Business Conditions Index since 2002. Looking ahead to the next year, they “expect a fall of approximately 10% for the major indices with wide dispersion between stocks and sectors.” This bleak outlook on the equities market contributes to the mixed signals and overall confusion amongst investors and analysts.

On June 19, cautious sentiment on the state of the economy grew even more when the Federal Reserve Bank made the decision to leave interest rates unchanged while also signalling that rate cuts would occur in the near future. This nuanced decision raised concerns about long-term economic growth and certainly contributes to the confusion surrounding the overall sentiment of global markets. The decision indicates that the Fed projects growth of the U.S. economy to continue in the immediate future but it also indicates uncertainty over the next year.

Chart IV - US Unemployment Rate

Chart IV - US Unemployment Rate

In taking a broad look at global markets, there is a stubborn combination of conflicting signals and indicators that have left investors and global markets in a state of limbo. On a macro-level, recent data has shown that consumer spending has improved in recent months, unemployment has remained remarkably low and American factory output is continuing to increase despite trade woes. On the other side of the coin, slowing wage increases and growing global trade tensions could force the Fed to lower rates to stimulate the economy in the coming months.

As we approach the end of a prolonged period of economic expansion assisted by quantitative easing by the Federal Reserve Bank that began in 2010, investors in global markets have been forced to play a more active role in decision-making and their investment strategies. Now that asset classes aren’t all on the rise as a result of quantitative easing and consistently low interest rates, volatility in the market has began to return as investors have to be more proactive and intentional in their actions. Interest rates are again becoming a factor to consider in global investing and this profound change is a driver for mixed signals across global markets. While this change certainly isn’t a driver for economic contraction, it is a sign that this prolonged period of economic expansion could be coming to an end. The mixed indicators in both equities and fixed income markets echo this sentiment and pave the way for continued uncertainty in the markets as summer kicks off.