Following the steep market decline at the end of last year, equity markets snapped back this year. While anxiety about Fed policy and intensifying trade wars waned, these issues remain, and headlines will shift market sentiment from day to day.
Thinking ahead to the remainder of 2019 and into 2020, we look at the most frequent questions we’ve been getting from our clients and how certain issues may play out over the foreseeable future. Below we discuss the top five questions on your mind.
Is the Federal Reserve really on hold? Following the tumultuous markets late last year and due to slowing growth and absent inflation, investor’s expectations for further rate hikes in 2019 were lowered, from four to two, and ultimately zero. In fact, the market is implying that the Fed Fund’s rate will be anchored at current levels for the foreseeable future with the next move likely lower, not higher (Display).
We would broadly agree that policy rates are unlikely to change for some time for two reasons. First, the Fed is reassessing what the “neutral” interest rate—the rate that does not cause or hinder inflation—actually is. Nobody really knows what the actual neutral interest rate is but the Fed has steadily lowered its median estimate from 3.75% to 2.75% and some think it may be lower. Second, the Fed is worried that inflation is too low. The Fed wants to keep inflation averaging 2% across the full business cycle; inflation typically runs well below 2% in bad economic environments, and above in good ones. But inflation has averaged only 1.4% over this 10-year expansion. So, to average 2%, the Fed may need to be more tolerant of higher inflation. The combination of a lower estimated neutral rate and a desire for higher inflation implies that rate hikes aren’t likely to happen in the foreseeable future.
Will the US pivot trade negotiations to other large partners?
We expect the US will reach a trade deal with China in April, but longer term, China and the US will likely engage in continued trade negotiations, and perhaps disputes, as the two countries grapple over their competing consumption, manufacturing, and technology priorities.
Most expect a deal with China will ease trade tensions, but the US has imbalances with many other trading partners, notably Mexico, Germany, and Japan. While the US-Mexico-Canada Agreement (USMCA) reached last November addresses key relations with those countries, the US may focus on other regions, most notably Europe over autos. So, while near-term progress with China would be positive for sentiment, markets may not have seen the last of trade-related disruptions.
How will Brexit play out, and over what time frame? A Brexit deal is still expected by most, but there is little clarity as to the nature and timing of a deal. Why are we, and the market, somewhat confident that a deal will be struck? Only a very small number of British parliament favor a no-deal Brexit, but it’s been a challenge to get those that want a deal to coalesce around a single plan. The same is true in the EU, in which most want to avoid a disruptive Brexit. There are likely to be many twists and turns before a resolution is reached, and even beyond, as Britain embarks upon a transition phase, and we believe continued headline risk and volatility will plague this market. That said, we continue to believe the most likely path is a deal, but a no-deal Brexit cannot be dismissed.
From an investment standpoint, if Brexit does eventually happen, we believe it will lead to higher inflation for the UK and its trading partners, as tariffs may increase and the flow of goods will likely slow. There is less direct impact on US companies, but indirectly, global uncertainty caused by a no-deal Brexit could impact global trade and market sentiment overall.
Is Europe becoming a global risk again? While Europe has recovered somewhat from its crisis in 2011/2012, growth has slowed recently. This slowdown is a result of four main issues. First, Europe is heavily exposed to world trade; exports account for 28% of GDP so as trade decelerated, so did Europe. Second, consumption diminished, as a higher savings rate and rising inflation reduced consumer spending. The last two were the result of rising populism: Brexit, as we mentioned above, is weighing on sentiment, and nationalism in Italy has led to tighter credit conditions.
Despite the slowdown, we believe a recession is unlikely. Recent policy enacted in China to bolster their economy will support global trade in the second half of 2019, benefiting European exports. And while consumption has slackened, real income growth and consumer confidence remain solid. The same is true for capital spending. The level of these metrics is inconsistent with recessionary conditions. Lastly, monetary and fiscal policy should benefit Europe this year. We expect fiscal stimulus to add to eurozone GDP by approximately 0.5% this year, while monetary policy remains highly accommodative, with expectations of tightening pushed out to 2020 at the earliest.
Is the expansion nearing an end? Roughly half of economists believe the US will fall into recession by the end of 2020; even more believe a recession by the end of 2021 is unavoidable. The problem with those predictions? Accurate economic forecasting is difficult going out just six months, and nearly impossible beyond one year. It’s natural to expect a recession given how long this expansion has lasted; it will hit the 10-year mark next month.
But time does not halt economic growth. Longer expansions are not unheard of—five countries are currently in the midst of expansions spanning 20 years or more including China, Australia, India, and Korea. And in the past, notable developed market expansions far surpassed 10 years—Finland and Sweden (15 years); Norway (16 years); Ireland (21 years); and the Netherlands (27 years).
Contrary to consensus expectations, it is our view that current data point to the possibility that the US could still be the middle of its expansion, rather than in the late innings. While we concede global growth is slowing, financial conditions—for example, interest rate levels, currency movements, and market volatility—are all supportive, making a sharp slowdown unlikely. And since interest rates and volatility retreated from last year’s levels, conditions have improved. History tells us loose conditions are supportive of economic activity.
Investing Cannot Be Done in Isolation
Markets are fluid, and fully intertwined globally. Many variables can pull them in any direction, and sometimes an event or factor can have a greater or lesser impact than anticipated. That’s why the complexity of the markets should never be taken for granted. As such, we continuously monitor and consider factors, such as these questions that are on your mind, that could impact the markets, and position our portfolios accordingly.
For more on trends in the economy, markets, and asset allocation for long-term investors, explore The Pulse, a Bernstein podcast series, and for additional thought leadership, check out the related blogs here.
The views expressed herein do not constitute research, investment advice, or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams.