Fourth Quarter 2019 Market Outlook:
Can Consumers Keep Economy Rolling as Manufacturing Slows?
Mark Simsenstad, CFA, Chief Investment Strategist | October 3, 2019
Entering the fourth quarter, the economy faces a number of unsettling factors, both globally and domestically:
- Tariff talks will likely dominate investment markets and the economic and geopolitical headlines in the weeks ahead.
- Corporate earnings reports for the second quarter are largely behind us and, therefore, unlikely to provide a catalyst to break free of the trading range for equities that's been in place for stocks since May.
- Interest rates continue to move down globally, suggesting the trends for a benign inflation outlook and tepid economic growth (at best) are likely to persist or moderate further.
- Commodity prices have been weak, providing an additional indication that an acceleration in economic activity appears unlikely.
- Brexit seems no closer to a resolution, as the new prime minister, Boris Johnson, struggles to build consensus.
- There are indications that U.S. manufacturing and industrial activity appear to be declining.
Consumers Buoy Economy
In the U.S., consumer sentiment, albeit off its highs, remains quite positive, undoubtedly a function of a strong labor market and reasonable wage gains. But beyond strong employment and retail sales trends, the economy faces some nagging challenges.
Undoubtedly, corporate behavior and the outlook for future activity are being impacted by the reinstatement of tariffs on China. Additionally, more tariff actions are being suggested for many of our other trading partners in Europe and the Far East, which further undermines business confidence.
Fortunately, to date, the uncertainty created by these actions has not manifest itself in weakening the labor markets in the U.S., which suggests consumer behavior should not change domestically. That said, should the challenges in the corporate sector persist, that would manifest itself in a diminished outlook for employment. We are monitoring the labor markets closely for any signs of weakness.
Monetary Policy Still Cautious
Central bankers have taken notice of the pockets of weakness in growth, particularly abroad, as well the uncertainties and risks created by the tariff issues. In the U.S., the Federal Reserve has taken steps to provide monetary accommodation by reducing the Fed Funds target rate twice in the past three months and indicated a willingness to take further steps if necessary.
There are real signs that economic uncertainty has increased. There are numerous indicators that monitor recession risk, both domestically and overseas, and at this point, many of them are flashing yellow. The primary catalyst for the deterioration has been weakness in the manufacturing sector, particularly those industries that are more sensitive to global trade and tariff issues.
A Broader Concern This Time
We saw a similar increase in recession risk back in 2015-16, but the catalyst then was the collapse in oil prices to below $30 a barrel and the flow-through effects on companies servicing that industry. When oil prices recovered, risk moderated, and the expansion continued.
Today, the weakness is less industry specific and more broad-based. One factor we are monitoring closely is global trade, as it tends to have a strong relationship to manufacturing activity. An improvement in global trading activity would likely indicate a positive inflection point for the corporate sector.
Resolution of the tariff issues would provide a more constructive economic and investment environment. At this point, there are few signs of progress on that front. Complicating the issue will be the upcoming U.S. election. Many players outside the U.S. are simply delaying any actions until they know what the makeup of the next administration will be.
For the financial markets, should the tariff uncertainty persist, it seems any meaningful improvement in equities is unlikely. A further challenge for stocks would be slowing profit growth. The most recent quarter saw slightly more than 3% revenue growth and less than 2% earnings growth. Third quarter growth is unlikely to be any better.
With the unpredictability of the tariff issue, extraordinarily low interest rates, a diminished outlook for global economic growth, and U.S. equity markets near an all-time high, we believe that a modest reduction in risk exposure would be a prudent strategy.