The steady stream of negative headlines would lead one to believe that our economy is mired in an economic crisis. Talk of an imminent recession seems to be all over the headlines. According to a recent Bloomberg survey, the number of articles mentioning the word “recession” reached a level last seen in late 2011. Legitimate headwinds within our economy do exist. The U.S. manufacturing PMI has steadily declined and business spending has slowed. Added to that is the constant turmoil in Washington D.C. and a presidential election next year.
Yet, while signs of a slowdown are present, the underlying fundamentals remain encouraging. The U.S. consumer is in very good financial shape. Consumer confidence remains near cycle highs and wages are growing. Unemployment is at a five-decade low and the housing market has been showing some signs of improvement with both new and existing home sales rising. The housing market has been bolstered by the Federal Reserve, which has embarked on a more dovish outlook, having lowered rates twice this summer—the first interest rate cuts since 2008.
Uncertainty around global trade negotiations with China, Mexico and Canada has led to increasing volatility across financial markets and a growing degree of risk aversion. While discussions between the U.S. and China continue, optimism for a comprehensive agreement has waned. Should tariffs escalate from here, especially the mostly consumer-related items scheduled to hit in December, it would have a greater negative impact on the general economy. However, recent news flow has been positive, as there is pressure on both sides to come to some agreement. It is a relief to see that some progress has been made, but there are likely to be more up and downs in the months to come.
In China, economic activity has slowed dramatically with a growth rate in industrial production of just 4.4%, the lowest level since 2002. With its heavy dependence on China, Europe is struggling as well. Today we have a global slowdown in manufacturing activity, which has been negatively impacted by higher tariffs. The Eurozone Services PMI reading of 52 remains positive but is well off the highs of last year.
In response to the slowing of global growth, massive monetary and fiscal stimulus has been unleashed around the world, giving investors some confidence that global economic growth will continue. A total of 43 central banks have now eased during this cycle.
Despite higher volatility and a sobering list of items on the wall of worry, our observations on the U.S. economy and market are largely unchanged from last quarter. Global weakness and trade issues will weigh on the market and the economy, but not enough to offset the momentum of a healthy U.S. consumer. Low interest rates and a yield curve teetering on inversion (where long rates are lower than short rates) seem to be more about global rates, growth and inflation expectations than our own economic situation.
U.S. stocks are not inexpensive, but our view remains the same as we wrote last quarter: a mild slowdown within an economic expansion, even one as long as the current ten-year run, provides a constructive background for stocks, although one that likely experiences more volatility. The current economic conditions outside of the U.S. may be more challenging, but there are still some attractive investment opportunities. With interest rates at historic lows, large fund flows are still being allocated to bonds and money coming out of equities. We presume this is a result of the extent of risk aversion, with many seeking safety with little return.
Warren Buffett has said, “You pay a very high price in the stock market for a cheery consensus.” For the most part there seems to be more risk aversion than widespread optimism today. While the volatility in the markets and uncertainty about the economy along with the geopolitical risks can be disconcerting, it may provide attractive opportunities for a long-term investor. We remain cautiously optimistic.
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