U.S. Outlook: September Ending on a Cautionary Note
For investors keeping your eye on the ball will become even more important in the quarter ahead. The formal impeachment inquiry that has begun in the House of Representatives will likely add to the daily market volatility in both the equity and the bond markets.
Not only because of how it could shape the 2020 U.S. presidential election outcome, but also what it might mean for the prospects for trade agreements between the U.S. and China, U.S.-Mexico-Canada-Agreement passage, and the Japan trade agreement reached only a few days ago. Trade agreements already reached with the Trump Administration could find a harder time getting passage in Congress. Furthermore, Congress may be less inclined to cooperate with the U.S. Trade Representative and demand more extensive changes in the language of current agreements.
If the Chinese trade delegation believes President Donald Trump is more politically vulnerable, they may hold out for an even better deal down the road. If so, the chances of additional tariffs and continued trade war uncertainty into 2020 will increase.Complacent Markets
The stock market initially took the news of impeachment largely in stride. Many analysts on Wall Street quickly dismissed the impact of impeachment on trade negotiations, the economy, and markets. However, I don’t see it quite that way. From my perch, I think the markets are a bit too complacent about the risks that continue to build in the global and U.S. economies. In fact, the hope of a China-U.S. trade deal sometimes seems like the only thing keeping the bulls in charge. One doesn’t have to look too far for signs of complacency. The VIX index, a proxy for future stock market volatility, has plunged from the August highs and yesterday stood just above a downward sloping trend line in place since 2011.
Even after the drop on Friday, the S&P 500 is still up 18% year-to-date. Meanwhile, Factset shows forecasts for a third consecutive quarter of negative earnings growth for S&P 500 companies in the third quarter. Just today, a report said that 82 of 113 S&P 500 companies that have reported earnings have issued negative guidance for the current quarter. The lowered forecasts appear to be driven by information technology, consumer discretionary, and healthcare companies.Toxic Mix for Markets
In the bond market, high-yield corporate bond spreads have narrowed by 81 basis points from August. They have narrowed by 181 basis points since the end of 2018. The corporate high–yield credit spread is still near current expansion lows. In other words, fixed income investors are still reaching for yield and happily taking corporate credit risk for very little compensation in terms of yield. This seems to be a very toxic mix of financial market complacency against a deteriorating backdrop of declining earnings and fading global economic growth prospects. Recent data out of Germany and the euro zone point to a possible recession in Germany and continued slower growth in Europe. Industrial confidence in the euro zone just hit the lowest levels since 2013.
Here in the U.S., a disappointing consumer spending report for August has led us to cut our estimate for Q3 real consumer spending growth down to 2.7% from a previous estimate of 3.5%. We now see third-quarter U.S. GDP growth slipping to 1.6% and Q4 GDP at an even slower 1.5%, down from 2.0% in the second quarter. An intensifying global slowdown and the escalating trade war will mean continued pressure on U.S. business investment and exports, with less support from a strong labor market and consumer going forward. It’s easy to become complacent when “buy the dip” seems to always work and stock market valuations hold just below record-high levels. However, before too long, the gravity of the deteriorating economic environment will bring market valuation back into line with deteriorating fundamentals.
To find out more, check out my U.S. Outlook.