Week Ending: October 4th, 2019 | Published: October 7th, 2019
Global equity markets sold off for a second straight week and bond yields retreated (sharply in North America) as the U.S. purchasing manager surveys disappointed and trade frictions expanded beyond U.S.-China to include the U.S. and Europe. The WTO ruled in favour of the U.S. in a long-standing battle over European subsidies to Airbus. As a result, the U.S. will impose tariffs on $7.5 billion worth of goods on October 18 (10% levies on jets and 25% on a variety of other products). The prospect of escalation looms large as President Trump is poised to decide by November 13 whether to tax European autos. At the same time, a WTO decision on the EU’s counter-case against Boeing is due early in 2020 that could potentially allow Europe to impose counter-tariffs. The bad news was tempered by a “not hot, but not too cool” U.S. employment report that added fuel to the notion the U.S. Federal Reserve (Fed) will cut rates. Odds for a third sequential 0.25% cut on October 30 rose to 76% from 43% on September 27.
Goodbye rotation trade, we hardly knew ya. The cyclical areas that had been the beneficiaries of the recent “rotation-trade” were hit hardest: the energy, industrials and financial sectors gave back half or more of their September gains. A deep slide for oil prices, and re-emerging global growth concerns, caused the energy sector to fall sharply – and industrials followed suit. Meanwhile, the financials sector swooned on the decline in bond yields. Bank stocks overlooked steepening North American yield curves but were ripe for a pullback after moving significantly higher between mid-August and mid-September (+9% in Canada and +14% in the U.S.). The information technology sector, which had been a source of funds for the rotation, increased the most, along with decent gains for the interest sensitive/defensive sectors: consumer staples, real estate and U.S. health care. The rotation lasted just long enough to catch plenty of short-term traders in a classic whipsaw.
For those of us more focused on long-term investing rather than short-term speculation, the weak data isn’t encouraging, but the data needs to be kept in context. The ISM Manufacturing index measure did drop to its lowest level since June 2009 and it has been declining for six consecutive months, but this is only the second consecutive reading below 50. That signals a slowdown, not a collapse - dire readings are typically in the 43 range. We still do not foresee a U.S. recession in the near term. Many warning indicators are not flashing: jobless claims (four-week moving average) continues to grind lower, the unemployment rate continues to fall (at a 50-year low), private-sector payrolls account for the lion’s share of employment gains and, while employment gains are slowing, the pace of decline is modest. Wage growth took a step back, but inflation remains tame. Auto sales that had been weak delivered a pleasant surprise and the trend here is stabilizing, ditto for the U.S. housing market. Absent trade frictions, this normal and natural slowdown would likely have been nearing its end. The problem, of course, is we aren’t without trade frictions – so we remain cautious, well-diversified and vigilant as time, fundamentals and prices evolve.
Chart of the Week: Multiple Signals Emanating from Global PMIs
Capital markets focused on the disappointing U.S. ISM Manufacturing and Non-Manufacturing Purchasing Manager Index (PMI) readings, but there are whispers of hope within and around the broader PMI data. The alternative manufacturing survey from IHS Markit Economics rose 0.8 to 51.1 and various U.S. regional surveys remained more upbeat. Within the ISM Manufacturing PMI, the new orders component improved, as did the ‘new orders minus inventories’ ratio – a metric we watch closely for a turn in the U.S. inventory cycle (which would likely look better if not for the Boeing 737 Max 8 issues and the strike at GM). Survey data out of China improved for a third straight month and the JP Morgan Global Manufacturing PMI improved for a second month, albeit remaining below 50 at 49.7. These small victories are consistent with our view that without the trade frictions, the global economy would be emerging from its third post-financial crisis slowdown by its own devices. Unfortunately, trade frictions remain and not only raise the uncertainty of a growth pick-up, but at a minimum, push out the timing and strength of one.
The week in review
Canadian real GDP (July) was flat m/m (versus +0.1% expected), leaving growth up 1.3% on a y/y basis. The softer start to Q3 suggests that growth is set to cool down after the strong 3.7% q/q annualized pace in the second quarter.
Canada's international merchandise trade deficit (Aug.) narrowed to $0.96 billion from a downwardly revised $1.38 billion deficit in the prior month (initially reported as $1.12 billion). Exports rose 1.8% m/m, while imports rose 1.0%.
U.S. non-farm payrolls (Sept.) rose 136,000 (versus +145,000 expected), while there were upward revisions totalling 45,000 to the prior two months. The labour force participation rate held steady at 62.3% and the unemployment rate dropped 0.2% to a 50-year low of 3.5%. Despite the tighter labour market, average hourly earnings dipped to 2.9% y/y from 3.2% in the prior month.
U.S. trade deficit (Aug.) widened to $54.9 billion from $54.0 billion in the prior month. Despite tariffs, the U.S. trade deficit is ~$10 billion (or ~20%) wider than prior to President Trump taking office.
Euro Area consumer prices (Sept.) eased to 0.9% y/y (versus +1.0% expected), while the core measure picked up to 1.0% y/y (in line with expectations).
September Global purchasing manager index (PMI) recap: U.S. ISM Manufacturing fell 1.3 to 47.8, Non-Manufacturing fell 3.8 to 52.6; Markit Canada Manufacturing rose 1.9 to 51.0, Canada Ivey Manufacturing fell 11.9 to 48.7; Eurozone Manufacturing was revised up 0.1 to 45.7, Services was revised down 0.4 to 51.6; and, China Manufacturing rose 0.3 to 49.8, Non-Manufacturing fell 0.1 to 53.7, China Caixin Manufacturing rose 1.0 to 51.4.
The week ahead
Canadian employment and housing data
U.S. inflation data
Minutes from recent U.S. and European central bank meetings
U.S.-China trade talks set to resume