Even though this rash of ugly data has emboldened those who are bearish, we still do not believe that a recession should be the base-case outlook.

Our Top Market Takeaways for the week ending October 4, 2019.

Market roundup

A no good, very bad week

Let’s take a quick look at all the bad news that investors had to deal with this week:

  • The ISM Manufacturing Purchasing Managers Index (a timely gauge of manufacturing growth sentiment) plummeted to its lowest level in over 10 years and was worse than every one of the 70 estimates that Bloomberg tracks.
  • Similarly, the Non-Manufacturing Index missed estimates and suggests the weakest growth rates since 2016.
  • Korean exports (a bellwether for global trade) continue to slow.  
  • CEO Confidence fell to the lowest level since 2009 amid tariff uncertainty and slowing global growth.
  • The United States got the go-ahead from the WTO to tariff around $7 billion worth of imports of European planes, Scotch, wine, cheese, olives, etc.  
  • Global semiconductor sales are 15% lower than they were one year ago.
  • Protests in Hong Kong continue to escalate.
  • The whistleblower complaint and resulting impeachment inquiry continue to add to policy uncertainty.     

As you might expect, stock markets did not appreciate the news. The S&P 500 lost -1.7% through Thursday, and Japan’s Topix fell -2.2%. The Eurostoxx 600 lost -3.6%, and the United Kingdom’s FTSE 100 dropped -4.6% (more bad Brexit news probably had something to do with that). Investors sought safety in bonds. Ten-year U.S. Treasury yields fell by 15 bps to ~1.53%, and 2-year yields fell by 23 bps to ~1.38%. After the no good, very bad week, investors are now putting an almost 90% probability of another 25 bps cut by the Fed at the October meeting.

There aren’t many silver linings for investors to take away: The data was bad, sentiment was bad, and risk asset performance was bad. But before we overreact to the new information, we think it makes sense to place it in a larger context.

First, let’s take a look at what makes us worried. The ISM releases mentioned above are the two most notable data releases that are cause for concern. We have mentioned before that the manufacturing sector globally has been slowing down, but the degree to which manufacturing growth sentiment missed expectations in the United States caught our attention. The superlatives speak for themselves: Every subcomponent was in contractionary territory, the new export orders component is below where it was in 1998 (when emerging markets were in turmoil), and the employment index reached 2016 levels. Surprisingly, the non-manufacturing measure (which covers industries like retail, finance, healthcare and transportation) slipped to levels last seen in 2016. We have been arguing that the manufacturing weakness was not spilling over into non-manufacturing, but this release puts a dent in that argument. We should also note that these readings could be a sign that the tariffs on consumer products from China that went into effect on September 1 could be having a real impact in the United States. 

What gives us comfort in our base case view of “no recession”? The ISM surveys are important, but they aren’t perfect. Since 1980, the ISM Manufacturing PMI has fallen below the 50 threshold between expansion and contraction 10 times. A recession only followed four of those instances; 40% is a great batting average, but a very poor recession indicator. Next, the ISM surveys are very popular gauges of activity, but they aren’t the only ones. Markit, another data provider, also released its manufacturing and services PMIs this week. Both measures were in line with expectations and signaled modest expansionary conditions. Further, the labor market has remained solid (the private ADP jobs and the Bureau of Labor Statistics non-farm payrolls reports both came in about in line with expectations, and jobless claims remain low), and actual income generated from workers in services industries has held steady despite the survey indicators falling off.

Even though this rash of ugly data has emboldened those who are bearish, we still do not believe that a recession should be the base-case outlook. While this week made it feel like things are getting worse, we believe that a more accurate interpretation is that the slowdown we have been forecasting is here, and it has been associated with falling interest rates and sideways equity markets.

Graphic showing the ISM Manufacturing PMI diffusion index from January 2016 through October 2019. The diffusion index is above 50, indicating an expansion, roughly from July 2016 through July 2019.

Graphic showing the U.S. 10-year Treasury yield from July 2016 to October 2019. The yield has declined from July 2018 through October 2019.

Graphic showing the MSCI World Price Index from January 2016 to October 2019. The index increased from January 2016 through January 2018. In 2018 and to October 2019, the index remained relatively flat.

We also take comfort in a U.S. consumer population that, compared to the last recession, looks decidedly less vulnerable. Not only is the unemployment rate very low, but household debt measures remain unthreatening, and inflation has been benign. With some 70% of U.S. GDP attributable to consumption, it’s not clear to us that the policy uncertainty and the mild manufacturing recession we are experiencing represent the beginnings of a widespread corporate retrenchment, a consumer meltdown, or an outright economic recession. 

So what should investors do? 

Our investment platform continues to take calibrated steps that are defensive, but not exaggerated. Investing is not binary, like a light switch. We view it more like a series of dimmer dials. Since the beginning of 2018, we’ve steadily dialed down the amount of risk in our managed portfolios and across our brokerage platform recommendations. In portfolios, a large equity overweight has been substantially reduced, while high yield credit has been shed in favor of more defensive core bonds. We’ve also rotated equity exposure to favor the United States, which tends to outperform its global counterparts when times get tough, while also favoring companies that are growing dividends or stand to benefit from secular growth trends. 

Taken together, the slowdown we’ve been expecting is now upon us. But it is too early to sound the recession alarm. While we will continue to closely monitor developments and adjust our investment approach as required, we are confident that the measures we have taken are appropriate for this environment, which is one defined by a slowing, but growing, economy. Within this environment, we believe that a goals-based focus on investing is critical for success.  

Don’t miss this!

Join our call discussing if the recession obsession is justified

On Tuesday, October 8, 2019, at 11:00 a.m. ET, we will host a live call to share our Quarterly Market Update. We will discuss why we’re recommending that investors maintain a balanced and strategic approach amid the recession obsession. Please join us as we offer insights on this topic and more.

All market and economic data as of October 2019 and sourced from Bloomberg and FactSet unless otherwise stated.

We believe the information contained in this material to be reliable but do not warrant its accuracy or completeness. Opinions, estimates, and investment strategies and views expressed in this document constitute our judgment based on current market conditions and are subject to change without notice.


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