Equity and bond markets retreated as the new Fed Chair Jerome Powell signalled a more hawkish personal stance. The Fed will be data dependent and has a 12 voting member FOMC but the signs are clear that barring unusually weak data, interest rates will be raised steadily. Adding fuel to the fire was the reigniting of a global trade war as Donald Trump imposed tariffs on steel and aluminium imports while the EU and China reacted with threats of retaliation. Trump’s response to the Europeans was to draw automobile imports into the fray.
Stocks fell broadly but the reaction was most acute among exporters and large index stocks (also most likely to be exporters) while the bond market was not spared. If the Fed is determined to raise rates the trade war did not help as trade protectionism can be very inflationary exacerbating the concern about higher interest rates across the whole term structure.
In politics, the SPD held a referendum supporting forming a coalition with German Chancellor Merkel’s CDU. This relieves some of the political worries in Europe. Germany has been without a government since elections held in September last year. Alas, the uncertainty has only just begun for Italy where polls suggest a hung parliament. Italy is caught between a coalition led by former fraudster and PM Silvio Berlusconi’s Forza Italia party or one led by the Five Star Movement founded by Beppo Grillo, a popular comedian.
Now last quarter we noted that global growth had deepened and widened and that no region was left behind. The trouble with such conditions is that they are difficult to improve upon. In the last month, higher frequency data has shown some moderation. We are in no danger of recession but the world economy is climbing down from a high induced by performance inducing policies. Here are some hairline fractures, tiny, nothing to worry about, yet.
- US new home sales: Sales of new single-family homes dropped 7.8% (mom) in January to a seasonally-adjusted annualized rate of 593k units, well below consensus expectations for an increase.
- German inflation a touch weaker than consensus.
- French inflation weaker than expected.
- US durable goods orders fell by more than expected in January, reflecting declines in commercial aircraft and defense goods orders.
- Japan: January output corrects sharply. Industrial production came in at -6.6% mom in January, a larger decline than the market forecast.
- China’s NBS February manufacturing PMI came in at 50.3, lower than January and also below expectations. The two key sub-indexes both declined – the production sub-index fell to 50.7 in February from 53.5 in January, and the new order sub-index went down to 51.0 in February vs. 52.6 in January.
These are not yet points of concern of course for on the other side we have:
- India’s real GDP growth accelerated further in Q4, once again led by higher growth in fixed investment. Real gross value added growth also expanded across the board. The Q4 growth data is reassuring since it suggests that the economy continues to recover from the past shocks of demonetization and GST.
- In contrast to the fall in the official manufacturing PMI, the Caixin manufacturing PMI rose slightly in February vs January. China’s Caixin manufacturing PMI edged up 0.1 to 51.6 in February, above market expectations.
- The Euro area Final Manufacturing PMI was revised higher by 0.1pp over the February Flash estimate, and remains in robust growth territory at 58.6, despite a 1pt decline on the month.
- USA: ISM Manufacturing Rises to Cycle High in February.
We are not saying that a recession is nigh, we don’t even see a significant deceleration, but when markets set themselves up for ideal conditions, the slightest disappointment can trigger big reactions.
The bottom line is that investors should invest over the long term when economic fundamentals find their way into asset prices. In the short term, asset prices reflect the emotional responses of investors who do not have a long term perspective. Now not all investors can or want to take a long term perspective. They will likely have less downside, if they are careful, but give up potential upside as they constantly adjust their exposures and lose traction from having liquidity in transit. It’s a trade off and each investor has to choose their own style. The worst thing is to oscillate between being a long term investor (usually when markets are rising) and being a short term investor (when they are falling), for then one has all the faults of one style of investing without the benefits of the other.