One of the reasons for the October pullback in share prices was a growing cry by some economists and analysts that we are headed for recession in late 2019. We do not see that happening. U.S. economic growth may be peaking this year, but 2019 is forecast at +2.5% GDP growth, and 2020 at +2.2%. Current conditions hardly suggest recession, remaining well above the average annual 1.8% GDP growth we’ve experienced since the Great Recession.
Another point analysts make is S&P 500 Q3 revenues were ‘disappointing’ and missed forecasts (as evidence the economy is slowing more than widely thought). But the top-line was still up 8.5% to be followed by expected 5.4% growth next year.
Recessions are the number one cause of bear markets but forecasting them can be very difficult. We do not see a recession immediately ahead but are observing other macro market factors closely as discussed below.
Macro Trends Impact The Markets
After years of spectacular markets, the grim reality of lower returns and resurgent volatility now threatens. Years of central bank accommodation (quantitative easing combined with zero or negative short interest rates) has given way to transition that now includes quantitative tightening (QT) and elevated volatility. Surprising aberrations such as the stock and bond markets’ simultaneous decline in October may be foretelling trouble ahead.
Several market trends have developed that bear watching. Among them:
U.S. Interest rate hikes cause damage:
|
Short Rates (Fed Funds) |
+100 bps to 2.16% (YTD) and highest in a decade |
|
Mortgage Rates (30Y Fixed) |
+105 bps to 4.82% (YTD) and highest in a decade |
|
UST 10 Yr. Yields (U.S. Generic) |
+84 bps to 3.18% (YTD) and highest in a decade |
Commodity prices break down to multi-year lows:
|
Energy Complex (oil) |
A decline of over 20% from the September high |
|
Base Metals (Copper) |
A decline of 20% from the June high |
|
Precious Metals (Gold) |
A decline of 12% from the April high |
Growing contagion across stock and bond markets:
|
China’s Shanghai Stock Exchange |
A decline of over 25% from the January high |
|
Italian Generic (10 yr note) |
+140 bps to 3.40% (YTD) and highest since 2014 |
|
EEM (Emerging Market ETF) |
Index of MSCI EM stocks decline 24% from January high |
So what’s the point?
Rising rates and “quantitative tightening” are destabilizing markets through diminished liquidity and higher funding costs. New and existing home sales have been slowing throughout 2018 as affordability ebbs.
Contagion is spreading, threatening already challenged stock and bond markets worldwide. Margin calls on privately held over-leveraged enterprises in China now threaten a stock market collapse.
Over time, the US is likely to feel the pressure as well…especially the high yield and leveraged loan markets as rising credit risks and defaults are appropriately priced into the markets.