Published on May 13, 2019
Latest Market Commentary
Economic conditions in China appear to be improving. In March, the manufacturing PMI returned to a level indicative of expansion for the first time in 4 months, and factory output reached its strongest level since late last year. While April’s manufacturing PMI was modestly below analyst’s expectations, it too remained above the expansion threshold. Industrial production and retail sales showed healthy gains during March and exceeded consensus projections. We think that these improvements are significant as China’s economic growth has decelerated every year since 2010. If growth in the world’s second largest economy were to stabilize or reaccelerate, we believe it could positively impact its trading partners and capital markets across the globe.
We attribute some of China’s recent strength to a significant tax cut implemented earlier this year, as well as liquidity injections from the country’s central bank. A successful trade deal with the US could give an additional boost to China’s growth profile. In this regard, we note that the two countries have reportedly agreed on enforcement mechanisms to police a potential trade pact. We believe this is meaningful as this issue had previously been a point of contention. We continue to expect the US and China to reach an agreement on trade, as it is in the best interest of both sides to do so, though timing is uncertain particularly in light of the events of the last few days.
In contrast, the European economy remains weak. The manufacturing PMIs for both March and April came in below 50, indicating that the sector is contracting. In its commentary, survey data provider Markit noted that “the economy remains in its worst growth spell since 2014. Manufacturing reported a further contraction and service sector growth cooled.” Moreover, GDP projections for Germany and Italy have recently been revised down. The Italian government now anticipates growth of just 0.1% this year. It appears that the ECB is closely watching these conditions, and is attempting to counteract them by delaying interest rate hikes and rolling out a 3rd round of its targeted long-term refinancing operations (TLTRO), which are loans to financial institutions at attractive rates that are designed to stimulate lending to the real economy. We are encouraged by the ECB’s efforts though the challenged European economy remains a risk to capital markets in our view.
We believe that the US economy appears healthy as evidenced by the recently released Q1 GDP report, which came in at a stronger than expected 3.2% annualized growth rate. There are reasons to believe that solid domestic growth may be sustainable, given the healthy state of the labor market and benign financial conditions. Perhaps most significantly, this growth is being accompanied by a general absence of inflationary pressures, which has enabled the Fed to remain dovish. In our opinion solid growth and an accommodative Federal Reserve typically bode quite well for stocks. Moreover, first quarter earnings are exceeding expectations. Investors were quite cautious heading into earnings season, with consensus analyst projections calling for a low single digit year-over-year decline in S&P 500 earnings. As of this writing however, with approximately 80% of S&P 500 companies having reported first quarter results, aggregate earnings are up 3.2%.
We believe there are reasons for caution. Stocks have been on a strong run, having moved up approximately 25% since last December’s low, but the recent breakdown in the US-China trade talks may create choppy market conditions in the near term. International economies remain challenged, though we suspect the worst may be behind them. Finally, as the 2020 US presidential election draws closer, we expect to hear a lot of potentially market-moving rhetoric on a number of important issues including health care, taxes and climate change. Market volatility could pick up as the candidates debate policy and make stump speeches on these topics. Despite these risks, we view conditions as generally favorable for investors in equities.