U.S. mar­kets 2019: Dips and op­por­tu­ni­ties

The Globe and Mail (Ottawa/Quebec Edition) - - REPORT ON BUSINESS - NEIL I RWIN

The forces driv­ing the re­cent volatil­ity are not any­thing new, nor are fore­casts of slow­ing growth in 2019-20

Af­ter an­other week of ex­cep­tional volatil­ity on Wall Street that has pum­melled stock port­fo­lios, there are two closely re­lated ques­tions worth ask­ing. First, why is this hap­pen­ing when the econ­omy is so strong? The Novem­ber U.S. jobs num­bers re­leased on Fri­day showed the un­em­ploy­ment rate re­mains at a rock-bot­tom 3.7 per cent amid healthy job cre­ation, just the lat­est piece of eco­nomic data to come in rel­a­tively strong.

Sec­ond, what took so long? Why are mar­kets just now rec­og­niz­ing the risks the econ­omy faces in 2019, which have been ob­vi­ous for months to any­one pay­ing at­ten­tion?

The forces driv­ing the re­cent swings – which have re­sulted in an 8-per-cent drop in the S&P 500 over the past two months, with some teeth-rat­tling ups and downs for stocks, bonds and ma­jor com­modi­ties along the way – are not any­thing new.

First, three years of in­ter­est-rate in­creases by the U.S. Fed­eral Re­serve are fi­nally start­ing to pinch in­ter­e­strate sen­si­tive sec­tors, par­tic­u­larly hous­ing, the auto in­dus­try and com­pa­nies with heavy debt loads. Af­ter years in which the econ­omy has be­come heav­ily tilted to­ward in­dus­tries that de­pend on low in­ter­est rates, a po­ten­tially painful re­bal­anc­ing is un­der way.

Sec­ond, in­vestors worry that the trade war be­tween the United States and China could start to pinch cor­po­rate earn­ings and eco­nomic ac­tiv­ity more than it has to date. But that con­flict has been build­ing through­out 2018.

Third, the tax cut that has lifted cor­po­rate earn­ings and eco­nomic growth in 2018 won’t be re­peated in 2019, mean­ing a harder slog for com­pa­nies seek­ing higher prof­its. Growth will slow un­less com­pa­nies de­velop ways to ex­tract greater pro­duc­tiv­ity from their (in­creas­ingly hard to find) work force, which would be great for long-term eco­nomic prospects, but isn’t the kind of thing you want to count on.

So the an­swer to the first ques­tion – of why mar­kets have be­come so tur­bu­lent when the U.S. econ­omy is strong – is the sim­pler one. Mar­kets look for­ward and the risks look­ing for­ward seem in­creas­ingly omi­nous even as ev­ery­thing con­tin­ues to go swim­mingly, es­pe­cially in the labour mar­ket, as 2018 nears its end.

The sec­ond ques­tion is a lit­tle harder. All of these ma­jor risk fac­tors have been openly dis­cussed among economists and the fi­nan­cial me­dia for the past year.

The con­sen­sus eco­nomic pro­jec­tions of Fed of­fi­cials pub­lished one year ago show that they ex­pected the econ­omy to grow 2.5 per cent in 2018 and 2.1 per cent in 2019. If any­thing, they were too pes­simistic about 2018, which now looks likely to be north of 3 per cent.

But slower growth in 2019 and ’20 has been ex­pected among main­stream eco­nomic fore­cast­ers ever since the tax leg­is­la­tion took shape a year ago.

And know­ing some­thing bad will prob­a­bly hap­pen is not the same as know­ing when. It ev­i­dently took an­other con­fus­ing se­ries of de­vel­op­ments in eco­nomic diplo­macy be­tween the United States and China for it to be­come clear.

“Most economists are good at an­a­lyz­ing fun­da­men­tals, but they know bet­ter than to fore­cast di­rec­tion and tim­ing in the same sen­tence,” Mr. Put­nam said.

So what mar­kets have right is that this is shap­ing up to be a per­ilous time for the econ­omy, in which bad luck or bad pol­icy could eas­ily cre­ate a ma­jor slow­down or re­ces­sion. And that’s the case no mat­ter how strong things look at the end of 2018 or how long it has taken mar­kets to reckon with that re­al­ity.

BREN­DAN MCDER­MID/REUTERS

Traders work on the floor of the New York Stock Ex­change on Fri­day. Rate pres­sures and trade-war wor­ries are push­ing stocks down head­ing into 2019, of­fer­ing in­vestors po­ten­tial open­ings to take ad­van­tage of lower val­u­a­tions.

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