China beating GDP estimates caused a rally in Asian shares and provided some relief around the globe. The reading of 6.4% growth was flat quarter over quarter and beat the 6.3% estimates. This all sounds like good news for the global economy stabilizing and will provide the Chinese government with the ability to scale back on stimulus. The larger picture shows that the stabilization of growth came from the real estate sector (construction, white goods, etc.) which are partially a result of the lowering of the reserve requirements for banks. Local governments were also given a near 60% increase in special purpose bonds this year which will contribute to growth.
Concerns come into play when you look at the longer term horizon and ow the Chinese government will cope with slowing growth year over year. The current process of adding more stimulus to the markets has, and will continue to work, but due to the rising concerns over debt in the country, the government will be less likely to resume the financial crisis era levels of assistance.
Once again when determining the reliability of the recovery we had this year we need to look at the debt markets for signals of how stable and long it will last. Equities will be supported by the strength in the lending market or be forced to adjust to the limitations of debt fueled growth.
Today the US Jobs numbers come out for March. Estimates are around 180k jobs being created, which is strong coming off the back of a 20k increase last month. Markets will be looking at how this is revised to help make a determination of whether the global slowdown fears are past us and there is room for more upside in the markets. Since the start of the year markets have rallied at signs of growth returning not just to the US but globally.
The market staged a great recovery from the sell-off late last year, now that we are back to the levels we saw before the drop, growth is going to influence the markets more than recovery. If this growth trend continues and the Fed stays in its wait and see stance, the markets could have the potential for new highs. With markets getting optimistic, there is potential for some upsets, so the approach to adding to your positions should remain measured, and cash should stay on hand.
Today UK Parliament will discuss and vote on the alternatives to Brexit. This will no doubt bring volatility into the markets and have investors waiting on the side lines for more information. Bigger picture the talks of a global slowdown are increasing (the bond market is starting to take notice) which isn't being fully reflected in the stock market as of now. Equities did have a series of declines as markets started to factor in the dovish Fed comments as being pre-emptive over accommodative. The fixed income market might be telling us that more trouble is on the horizon.
The US treasury curve has inverted seeing the 6mo and shorter yields higher than the longer dated yields, out to the 10yr. This inversion makes many investors nervous about the future economic prospects because so many are willing to get less return for longer protection of their money. As we have seen in the past an inversion denotes fear, fear brings an increase in savings and less investment, and less investment brings a slowdown. The issue is more in the timing of these events and the severity. For investors this is a good time to get your cash ready to deploy as the fear of the slowdown starts to become self fulfilling. In deploying cash, this means paring back on some investments that have had good rallies in the past few months and possibly not rolling over longer term bonds that you may have maturing. I wouldn't recommend a total liquidation in your portfolio (probably ever) as over the long term staying invested is the best way to capture long term returns. This is more a move to re-allocate over the coming months or year.
In Europe there are larger factors at work. The Fear of Brexit is at the center of everyone's mind and looking longer term, the outlook doesn't get much better. The data coming out of the Euro area is pointing to a steady decline in economic activity. This is bringing up some of the fears that have plagued the region during the crisis in 2011/12. s you ca see with German bunds (the safe haven of the Eurozone) investors are willing to pay a small price to protect their money, for up to 10 years. The ECB has been a contributor to this trend by pledging to keep rates the same until at least the end of 2020 and to continue to buy assets under their purchase program (of which there aren't enough German bunds to buy at reasonable prices). The sectors that are hit by these declining economic conditions in the EU are banks and industrials. Longer term I want to buy into these sectors, but cooler heads must prevail. Industrials can offer some decent yields, and would be easier to buy and hold through a rough patch. The banking sector will need to strengthen its capital structures and eliminate the fears of sovereign debt risks before they start to look attractive. Moving higher up the capital structure might be a better option in the near term, looking for preferred shares or bonds of financials companies. The key here is patience, as in the US market, it is good to have cash on hand and wait for opportunities to buy into good companies being sold off as liquidity becomes more valuable.
This week will be dominated by the Fed interest rate decision and meeting. While there is no expected rate increase at this meeting, the conditions have changed drastically over the last few months. The markets are pricing in a 25% chance of a rate cut by the end of the year and no chance of a rate increase. The importance of this meeting will be the insights of what the Fed plans to do with their balance sheet reduction schedule. Investors will be looking at how the Fed plans to continue, or delay, the balance sheet reduction in the wake of global economic trends. Other central banks have made it clear that they plan to keep their balance sheets as is, or expanding. It will be important to see if the US continues to buck the global trend or not. If so this will keep assets coming into the US Dollar, and dollar denominated assets.
A second factor to watch this week (though still interest rate related) is inflation numbers. The UK in the midst of Brexit is going to release their numbers Wednesday, with the Pound relatively range bound there isn't too much expectation of inflation getting out of control in the near term. The next day the UK will announce its interest rate decision with no expected action. Japan and Canada will also provide inflation numbers with forecasts near the previous levels. Large changes to the upside in these numbers will create a conundrum for central banks as they prepare for lower growth. A shrinking inflation number will provide the central banks with an open field for more monetary expansion in the event of slowing growth.
A second vote in UK parliament is taking center stage today. After the defeat of the new Brexit deal, a vote on whether to go ahead with a no deal Brexit is being voted on. Many are hoping this is going to be defeated and leave the UK with a final vote this week on delaying the March 29th deadline. The likely outcome (given the relatively low volatility) is that the can will be kicked down the road. This will not be good for UK businesses and banks which will most likely hold back on lending and expanding businesses among the uncertainty.
Meanwhile in the rest of the world there is a picture that is being built outside the events of Britain. The global economy is showing signs of slowing, being offset by central banks coming out with more dovish language as the start of the year rolls on. This has many investors wondering if central bankers are coming in preemptively to get ahead of a coming slowdown or adjusting to one that is already starting. With central bank rate changes taking about 18 months to flow into the markets properly, the language and guidance they are giving more important in the near term than actual changes to rates or asset purchases. The reasoning will depend on the data and vary by central bank.
In the US, there is more of an assumption that the Fed is being preemptive. Data (with the exception of the last jobs report) has been supportive of the economy. Inflation expectations have come down, but not in a severe way that will show easing as imminent. Data coming out today (like PPI) will help to build the picture around the Fed's stance on interest rates longer term.
For other banks, like the ECB, there are more tangible steps being taken. While the Fed is looking to be 'patient'
The Pound rallied in early Tuesday trading in Asia as new that the European commission agreed to changes to the Brexit agreement. This is the final chance that the UK will probably have for negotiations with the commission before the end of March deadline. With a vote on the deals coming on Tuesday, there will be another vote Wednesday, should this one be rejected, to determine if they should leave without a Brexit deal. If none of those are passed then a delay in the Brexit will have to be voted on.
One thing to keep in mind, is that the macro picture we are seeing will not improve as a result of the Brexit outcome. So while we might see an increase in volatility in the event of a no deal, the Euro is still likely to suffer in the longer term as slowing global growth will test the central banks and their ability to soften the blow. These monetary policies will only be able to do so much with most central banks (the US being an exception) still near the top of their easing cycle. Fiscal policy and the ability for banks to lend will be the main factors in managing through the next slowdown. The Euro area is suffering in both of these areas because of the 'Doom Loop' where banks hold sovereign bonds, and the lack of political will for the better off countries in Europe to help direct capital where it is needed most.
This is where you could see some resurgence in the UK economy after the Brexit deal (the outcome of the deal will determine the length before growth comes around) where lending starts to open up as less uncertainty causes banks to boost capital. The outcome of this week could provide opportunities to look at buying UK assets over European ones as Brexit winds down and the overall macro economy is taken into account in Europe.
A string of data from the Eurozone is pointing to lower growth in the region. Sentiment was at a 2 year low, German business growth is expected to fall "well below" the 1.5% targets according to the central bank chief, and importantly, corporate lending in the region slowed.
According to the ECB, corporate lending declined in January exacerbating the downturn in the region. This is a start to the confirmation that the slowdown in the Eurozone is continuing and the moves by the ECB will have to be followed to see how they are able to react to these changes. The Fed chair is going into his second day of testimony to Congress, shedding more light on what the Fed is looking for in data and how they will react. The ECB will have to start thinking of what policy tools they can politically use in order to calm the fears of the Eurozone countries in the face of slower growth.
Markets are starting the week on a positive note. Talk of the trade tariffs being delayed has the Chinese stock market entering a bull market and the US futures are pointing to gains of around 50 basis points (half a percent) at the open. Oil prices are hitting highs for the year on supply cuts and optimism. Extending the increase in tariffs that were due to go into effect is a positive sign that normalization in trade can occur. This boosts the prospects for the economy as well as markets in which a normalized trade relationship with China (and other countries), with the help of an accommodative Fed, will produce steady tailwinds for 2019. This week Reality will test some of these assumptions.
Tuesday will start the week with a 2 day testimony by the Fed chairman. This will provide investors with more clarity on the stance of patience and data dependence for 2019. The US will also announce home prices and Crude oil stocks.
On Wednesday the Euro area announce business confidence numbers which will be important to determining if the slowdown in the region is more pronounced going into the final month for Brexit talks.
Thursday has GDP numbers coming out for many countries (including the US) as well as UK consumer confidence and German inflation. This will be a big check on the European Disunity play we are currently looking at. Whether the eurozone slowdown can be slowed, and eventually reversed, in the current political climate of the region. China's bull market will be tested with data, having the manufacturing PMI coming out. The numbers are expected to come in slightly below 50 (signaling a contraction).
Friday will see US numbers on Income and manufacturing which will be compared to the unemployment and inflation numbers of the euro area. Depending on how other regions report, this could show the US bucking a trend of slowing growth or falling in line (confirming the Fed's recent dovishness). Finalized PMI numbers will come out from the Euro Area which was barely in expansion at the last reading.
In Summary the market optimism we are seeing in the week will have the chance to continue should the week show the Fed taking precautionary steps with policy as US numbers still impress, China starting to see signs of strength in manufacturing to piggy back on trade talks, and the Euro area displaying resilient business confidence in the face of Brexit. If these assumptions seem lofty then we could start to see this Monday rally struggle as the start of March begins.
British unemployment stayed at 4% today with claimant counts being revised lower than expected. Construction output in the EU was not as upbeat, coming in lower than estimates. Thursday will see the EU PMI numbers come out which have been slowing down to the 50 range over the past 6 months (a number below 50 denotes a contraction). As Germany is flirting with a technical recession and Brexit looming, it will be important to see how the EU is affected by these trends. Some countries are better prepared for a slowdown (US) or have the ability to take decisive action fiscally and monetarily (UK), the Eurozone could struggle with the sense of unity and political will to counteract a slowdown.
US monetary policy:
As mentioned, the Fed has been raising rates in the past and now stands in a holding pattern to monitor the slowing growth around the globe. On Wednesday the FOMC minutes should shed some light on the recent trend towards monitoring the impact of past rate increases. An important measure is the change (if any) on the balance sheet reduction program. After buying up $4.5 trillion of assets during the financial crisis to boost liquidity, the Fed has been reducing the amount of assets it holds by about $40bln a month. A change in the level that the Fed sets as neutral will be important to the stability of debt levels and the Dollar.
There is a little over 6 weeks before the Brexit date is reached. Without a deal the UK risks falling out of the European Union without trade deals, or a solution on the border of Ireland. This would no doubt cause a lot of volatility in UK assets up to the departure date and beyond depending on the outcome. Since the vote to leave the EU in June of 2016 we have seen the effects of the decision on the currency, markets, and economic numbers. As an investor with a longer horizon, how should you look at these events as they unfold and uncertainty depresses prices.
Looking at the headlines it seems the Eurozone is the obvious winner if the UK suffers a hard exit. Goods from the UK to mainland Europe are small in comparison and many companies have already started to move staff and jobs out of Britain. Looking at the overall economic growth globally the Eurozone might not fare as well as many expect. Aside from the Brexit uncertainty global growth is slowing down and the Eurozone is no immune. In the event of a slowdown the UK is in a better position to provide stimulus to their economy and the depressed Pound will help with exports.
The Eurozone didn't see the economic decline that the UK did after the vote to leave, but since the slowdown started, the Euro countries were hit hard by their intertwined bonds and banking system and the end of massive QE stimulus. One of the major themes we are following is European Disunity, a slowdown in growth and the lack of political will for more monetary accommodation, many of the countries are starting to undertake fiscal stimulus. This is a good sign that the European governments are aware of the problems, but it raises the concerns about which countries can afford to add a lot of stimulus and which cannot. This could create the two speed Europe we have seen in the past, only this time the ECB could have mixed data on their hands.
While Brexit is not great for the UK and will see volatility in the coming months, take into account the larger economic trends and who would be most likely to manage and come out of an economic slowdown quickly, should one occur. In this scenario the UK looks much more nimble and has the ability for more monetary and fiscal stimulus. Now would be the time to sit back and wait to start buying.