Markets are giving only mixed signals
But if US stocks are close to a slippery slope, emerging markets may prove a safer haven
One good thing about being bombarded with mixed messages is you’re bound to hear something you like. That could explain why the stock market keeps setting new highs despite a sluggish economy and stagnant corporate earnings.
But the new highs have been marginal. The market hasn’t made much net progress since early last year.
President Donald Trump’s tweets on trade have been uniformly exclamatory, but their content toggles between combative and conciliatory. And the Federal Reserve’s announcements on monetary policy have gone from tight to loose over the past year, to a bit of both at its meeting last month.
Wall Street seems to have become less sensitive to announcements from Washington. Traders appear to be waiting for some significant, definitive development to provide the conviction to buy or sell.
“It doesn’t seem like there’s much activity going on, but a lot of transitions are taking place,” said Bradley Klapmeyer, manager of the Ivy Large Cap Growth fund. “The question for investors is, now that the economy has slowed down and the Fed is responding, what’s the next thing you have to do? It’s a tricky time.”
It often is, which is why financial advisers encourage investors to maintain a portfolio well diversified among stocks, bonds and cash. With economic, corporate and even political conditions more shaky and uncertain than usual, that perennial advice seems especially apt now.
For professionals who hope to beat the market and one another, a neat trick in the months ahead may be to guess correctly whether years of poor performance by value stocks will be undone to any great extent. Value stocks, those in economically sensitive sectors like energy and basic materials, leapt for several days in September while defensive, stable-growth sectors such as consumer staples and utilities sank.
The answer, crucial for portfolio returns over the next several months, may become apparent once another question is resolved: Can a resumption of easier Fed policy provide enough of an economic second wind to prop up earnings in cyclical industries?
Doubts about Fed policy have led investors to send some mixed messages of their own. The S&P 500, which rose 1.2 per cent in the third quarter, experienced a sharp sell-off after a rate cut at the end of July and a rally after a second cut in mid-September.
Traders don’t seem to be taking the Fed’s hint that this is a two-and-through easing cycle all that seriously. Prices of interest rate futures imply another cut later in the year, so the market forecast is more like: three and we’ll see.
Klapmeyer is less hopeful about a revival of economic growth. That should favour defensive stocks, but with so many investors owning them, he wonders whether they’re still all that defensive.
“If rates stay low for an extended period, which is a reasonable assumption, I think those names will hold their multiples until the situation changes,” he said, “but I’m very cautious about valuations in those sectors.”
Go big on tech stocks
He prefers industries like software as a service and business services that are innovative and have high barriers to new competitors. Their valuations have increased, too, but they are able not just to maintain decent earnings without the help of a strong economy, but to increase them at a healthy clip.
The recovery of cyclical industries was hard to spot in fund results from the third quarter. Consumer cyclical stock funds returned 1.8 per cent, according to Morningstar, trailing the 3.9 per cent gain for consumer defensives. Utilities funds were standouts, rising 6.6 per cent, while energy stock funds slipped 0.8 per cent.
Luca Paolini, chief strategist at Pictet Asset Management, is far less optimistic about economic growth. “Next year, I think the US economy will deteriorate significantly,” he said. “I see a much more recession-like scenario.
“What’s going to be the catalyst? Nobody knows. They never know. Any small thing, at some point, can tip the balance.”
One problem with gauging the economic outlook is that routine data releases contain plenty of conflicting information, too. Readings generally have improved, but only after a run of notable weakness, and employment and wages have held up well for many months.
But other indicators, particularly related to manufacturing, have fallen, and earnings for the S&P 500 companies are forecast to increase just 1.2 per cent this year, according to FactSet, after rising 20.2 per cent last year.
Sharing the pain
Economic sluggishness isn’t confined to the US, either. In its latest forecast, issued last month, the Organisation for Economic Cooperation and Development (OECD) warned that the “global economy has become increasingly fragile and uncertain, with growth slowing and downside risks continuing to mount”.
The International Monetary Fund warned of the mounting global cost of America’s trade dispute with China, and David Malpass, the World Bank president, said his organisation would soon ratchet down its economic forecast for the year.
In its report, the OECD attributed the economic deterioration, which applied to nearly all of 20 countries studied, to “trade tensions and policy uncertainty”. The performance of the US economy and stock market may hinge on whether the trade dispute that Trump is engaged in, especially with China, is resolved sooner rather than later.
The tariffs imposed on imports by the Trump administration raise prices paid by American consumers. A study by two economists, Kirill Borusyak of University College
London and Xavier Jaravel of the London School of Economics, estimated that the tariffs could cost the average American household roughly $460 (Dh1,688) a year, if they remained fully in place for an extended period.
Those are not the only costs. Tariffs and import restrictions imposed in retaliation are causing substantial damage to US exporters, and the uncertainty created by the conflict makes businesses less inclined to invest and expand.
China too
Chinese stocks have been hit far harder lately — the Shanghai Composite Index fell six per cent in the six months through September, while the S&P 500 rose five per cent — although the economic effect of the trade dispute on China may be more muted. Andy Rothman, an investment strategist at Matthews Asia, said that China’s economy has evolved to the point that net trade — the difference between imports and exports — accounts for just one per cent or so of growth. The gap is more than two per cent in the US.
With Chinese consumer income and spending having grown at triple the rates experienced in the US last year, Rothman called China “the world’s best consumer story”.
Paolini said he thought the trade dispute would be settled without much more damage. “I don’t see this escalating in a way that makes it trigger something worse,” he said. But he added, “There are so many flashpoints you can point out” in international relations that “any small spark can trigger something”.
Despite such concerns, some American strategists find foreign stocks a better option, especially for investors worried that the US economy won’t pull out of its stall. They note that foreign stocks tend to be far cheaper and that foreign economies are weaker and so more likely to recover sooner.
Paolini similarly considers this “probably the best time to invest more abroad,” he said. “The US has been leading the cycle, and almost every cycle has a change in leadership.”