Economy still trundling forward

Today, borrowing heavily from a current piece by RBC’s Global Asset Management group, I touch on a few arguably interesting, and certainly salient, financial issues we are up against this year. Financial markets have been choppy throughout 2019, but volatility ramped even higher over the past week, with the U.S. S&P 500 Composite Index recording swings of more than one per cent in five out of the six trading days between Aug. 12 and 19. Aug.14 was, by far, the most violent, with a sharp 2.9 per cent decline. At its worst, the equity index closed down 6.1 per cent relative to its late-July peak.

Subsequent days have managed to reclaim a fair chunk of the decline, with the Aug.19 reading now a mere 3.2 per cent lower than the late-July peak, and level with readings from a few weeks ago.

Bond yields have mostly continued their lengthy downtrend, with the U.S. 10-year yield now just 1.59 per cent, which is nearly 50 bps lower than a mere month ago, and well over a percentage point lower than a year ago. The macrorelated motivations for these market jitters include slowing growth, mounting protectionism, the aging business cycle, Brexit expectations and the perception that the U.S. Federal Reserve Board (Fed) is treading too gingerly in its delivery of monetary stimulus.

Notably, the U.S. two-year to 10-year bond spread temporarily inverted last week. Although it has since re-normalized, this was a big part of the financial market’s sudden concern as the two-year–-10year

spread is considered by many to be an even more important signal of coming recession than the three-month–10-year spread that has already been inverted for several months. Loosely speaking, the former is considered better for predicting recessions, while the latter is better at predicting central bank rate cuts.

In reality, it is not binary – both say something about the economy and monetary policy. It is notable that the three-month–10-year spread also unwound its first inversion earlier in 2019, only to reinvert more enduringly later.

To recap global economic weakness, manufacturing indicators have fallen substantially since the start of 2018. Germany just reported its second quarterly decline in economic output in the past year, leaving the annual rate of GDP growth at a bare +0.4 per cent.

Chinese deleveraging may be at least in part to blame, given the two countries’ close commercial ties.

In aggregate, this economic weakness is unwelcome. Although it still falls well short of a recession, the case for one continues to mount. RBC’s business cycle scorecard argues for a “late cycle” interpretation.

On the other hand, a variety of forces for good are pitted against the gloomy economic trend.

China has just announced that it will better align its policy rate with the actual borrowing rates that bank customers pay, which could have the equivalent stimulative effect of a rate cut of nearly 50 bps.

U.S. Federal Reserve Chair Powell is expected to reverse concerns, which arose following the central bank’s last meeting when the Fed was only lukewarm toward further rate cuts. Stay tuned.

The recent U.S. fiscal stimulus, (inexplicably initiated near the peak of the economic expansion) is nearing expiration. But globally, the German finance minister acknowledged willingness to deliver something on the order of 50B euros of fiscal stimulus in the event of an economic downturn.

Suffice it to say fiscal levers still exists and Keynesian (votebuying) principles are still widely followed.

That public debt loads are already high is concerning, but not enough to stop governments from doing what they want: the cost of borrowing, after all, is stunningly cheap.

The growing North American service-sector shows a less volatile growth trajectory than other sectors, helping smooth things out.

U.S. consumer confidence is still notably robust, and the sector constitutes by far the greatest share of GDP.

On balance, despite increased risks, RBC continues to acknowledge the possibility that the economic expansion will defy fears and continue to trundle forward.

I just spent 45 minutes trying to work the word “trundle” in to this article.

My day is complete.

•••

Interesting fact.

Toronto has enjoyed remarkable population growth in recent years, sustaining a building boom that has raised eyebrows in terms of the number of cranes on the skyline, but which ultimately aligns fairly well with actual housing demand.

The Toronto metropolitan area enjoys the second-fastest population growth among North America and European cities, adding around 120,000 new residents per year. That’s about 1.5 Prince George’s each year. (Dallas sneaks slightly ahead).

Even sunbelt boomtowns such as Phoenix and Houston lag moderately behind, while behemoths such as New York, Los Angeles and Chicago are in outright decline.

In a Canadian context, Toronto was responsible for nearly a quarter of overall population growth in recent years. Running at 1.9 per cent per year on a population of 6.4 million, this growth rate is roughly double the national rate, but not wild.

The city’s population growth is supported by a vibrant economy, increasing economies of scale, a high level of national immigration, strong immigrant communities and a robust service sector that includes major financial institutions, a myriad of head offices and a rapidly-growing tech industry. They also have the Leafs.

— Mark Ryan is an investment advisor with RBC Dominion Securities Inc. (Member–Canadian Investor Protection Fund), and these are Mark’s views, and not those of RBC Dominion Securities. This article is for information purposes only. Please consult with a professional advisor before taking any action based on information in this article. See Mark’s website at: http://dir.rbcinvestments.com/mark.ryan