Investment Clock insights

Silver linings amid the chaos


Trevor Greetham

15 August 2019

Stock markets have fallen sharply over the last month after President Trump surprised the world (and his closest advisors) by announcing a new 10% tariff on a wide range of Chinese goods. He was frustrated that the US Federal Reserve’s (Fed’s) July interest rate cut, the first in 10 years, was only a quarter of a percent. We suspect he wants to see more aggressive interest rate cuts this year to boost the US economy ahead of the November 2020 Presidential Election and thinks announcing new tariffs is a way to get them.
This is a dangerous tactic. Business confidence was already at a low ebb and investors fear a further ratcheting up of trade tensions along with a possible No Deal Brexit may be enough to push major economies into a full blown recession. Weak Chinese data and a second quarter contraction in the UK and German economies have added to the gloom and long-term bond yields have dropped significantly. 
The UK and US yield curves have moved into inversion, a condition in which long-term government bond yields drop below short-term rates. Yield curves tend to invert ahead of recessions but the leads can be very long, anywhere between 10 and 33 months over the past five US recessions (chart 1).

Stock markets have fallen sharply over the last month after President Trump surprised the world (and his closest advisors) by announcing a new 10% tariff on a wide range of Chinese goods. He was frustrated that the US Federal Reserve’s (Fed’s) July interest rate cut, the first in 10 years, was only a quarter of a percent. We suspect he wants to see more aggressive interest rate cuts this year to boost the US economy ahead of the November 2020 Presidential Election and thinks announcing new tariffs is a way to get them.

This is a dangerous tactic. Business confidence was already at a low ebb and investors fear a further ratcheting up of trade tensions along with a possible No Deal Brexit may be enough to push major economies into a full blown recession. Weak Chinese data and a second quarter contraction in the UK and German economies have added to the gloom and long-term bond yields have dropped significantly. 

The UK and US yield curves have moved into inversion, a condition in which long-term government bond yields drop below short-term rates. Yield curves tend to invert ahead of recessions but the leads can be very long, anywhere between 10 and 33 months over the past five US recessions (chart 1).

Chart 1

There are silver linings. Shorter term lead indicators are improving. Our global growth scorecard is a good six month lead indicator for the world economy and it has been recovering since March, helped by an improvement in US consumer spending and the housing market (chart 2). Moreover, central banks have started to ease monetary policy and, with inflation low, they will keep cutting interest rates until the world economy responds.

Chart 2

Our investor sentiment indicator is deep in oversold territory with private investors bearish and volatility high (chart 3). We don’t expect an immediate turn around given the slow moving nature of trade disputes and the approaching 31 October Brexit deadline, but we are adding to equities on weakness in our multi asset funds. Things may get worse in the near term, but the worse they get, the more interest rates will be cut, the more money will be printed and the greater the prospects are for a pick-up in global growth going into 2020. At 10 years, this is the longest economic expansion in US history but there’s a good chance it rolls on for a while longer yet.

Chart 3

Past performance is not a reliable indicator of future results. The value of investments and the income from them is not guaranteed and may go down as well as up and investors may not get back the amount originally invested. The views expressed are the author’s own and do not constitute investment advice. Portfolio holdings are subject to change, for information only and are not investment recommendations.