This past weekend, I had the opportunity to see a production of Macbeth. Though I’ve heard the words many times before, I was particularly fixated by a verse from one of the witches: “By the pricking of my thumbs, something wicked this way comes.” The “pricking of thumbs” was originally intended to represent the historic belief that people could sense when evil was approaching. However, I couldn’t help but think this was a timely analogy for the sensations some market participants are feeling that an economic slowdown is approaching.
We heard last week from U.S. Federal Reserve Board Chair Jay Powell, who noted he is seeing “concerning” signs of a global slowdown. Recently the People’s Bank of China warned of a slowdown as well. And prickling thumbs were not needed to see that gross domestic product (GDP) in the eurozone declined to 0.2% in the third quarter, just 1.7% year-on-year. This contrasts starkly with 0.4% rates of growth for both the first and second quarters, and a 2.7% annualized pace for the fourth quarter of 2017. Adding to the negative picture was last month’s increase in eurozone inflation, which rose to an annual rate of 2.2%, up from 1.4% a year earlier.† This may make it more difficult for the European Central Bank to remain on course to end tapering at the end of 2018. Given that last year’s global growth provided an important tailwind for the U.S. economy, it makes sense for the Fed to be on alert and closely monitoring the global growth picture.
More troubling was what Jim Cramer shared last week on his CNBC show: “So many CEOs have told me about how quickly things have cooled.” He added: “So many of them are baffled that we could find ourselves in this late-cycle dilemma that wasn’t supposed to occur so soon.”
The Fed looks poised to respond to a slowdown
I have worried for some time that the growing trade wars and central-bank tightening would conspire to cause a tangible, albeit modest, slowdown in global growth. The good news is that the Fed finally seems to be concerned – and poised to act.
Recall that the stock market wasn’t sure what to make of the Powell-run Fed – hence the sell-off in February as the baton was being passed from former Fed Chair Janet Yellen to Powell. Until last week, it wasn’t clear that the Fed under Powell was still data-dependent, given the more rapid and regular pace at which rates were raised this year. Last week’s comments by Fed Vice Chair Richard Clarida were very important, as he confirmed in an interview that the Fed is still data-dependent. What’s more, Clarida shared the view that the Fed is near neutral, which seemed to contradict Chair Powell’s recent comments that the Fed is a “long way” from neutral. Clarida’s comments came a day after Atlanta Fed President Raphael Bostic articulated the view that the Fed should take a “tentative approach” to raising rates given their proximity to the neutral level. This also comes the same week that Philadelphia Fed President Patrick Harker said that he was “not convinced” a December rate hike is prudent.
This is further confirmation of what I have expected. I believe that while the Fed is likely to raise rates in December, it is likely to take its foot off the accelerator to some extent in 2019. And the fall in U.S. Treasury yields at the end of last week suggests other investors are starting to suspect the same thing. Quite frankly, now that we are beginning to get the scent of a possible slowdown, I believe this is a good time for the Fed to begin communicating to investors that it is data-dependent and ready to respond to weaker data.
Geopolitical headwinds have continued to play out
Of course, there are a number of negative headwinds that could have an impact on global markets, including Italy’s budget and the Brexit debacle.
We were taken on another roller coaster ride last week as U.K. Prime Minister Theresa May announced an agreement for leaving the European Union. This announcement was followed by the resignation of several members of her cabinet (most notably, the Brexit minister), as well as building momentum in the movement to vote “no confidence” on May.
I happened to be in London last week to watch this unfold first-hand. I asked my cab driver what he thought of the Brexit deal that May was promoting. He responded, “You’re from America, right? Tell me this: Do the turkeys vote for Thanksgiving in America?” He went on to explain that he doesn’t want a Brexit and wouldn’t want a “yes” vote on this plan. Now, admittedly, as a London cabbie, he benefits from greater international trade and tourism – but he suspected many others outside London were also starting to recognize they benefit from the same.
I can’t help but wonder if we ultimately will see another Brexit referendum held in the U.K. After all, knowing what they know now, British voters may vote differently if the referendum were held today. In the meantime, the impending Brexit has been causing market turmoil. The pound sterling fell last week, as did the FTSE 250 Index. I believe this was a knee-jerk reaction to the dramatic events of last week and the growing uncertainty of the Brexit situation, but I expect we will see a recovery when we get greater clarity.
This week, we will want to monitor five key issues.
- Trade developments. I had held out hope last week that the trade situation would improve based on U.S. trade advisor Peter Navarro’s comments that it seemed that “globalists” were making progress in changing President Trump’s mind on the burgeoning tariff war with China. However, based on this past weekend’s Asia-Pacific Economic Cooperation meeting, I expect the trade situation to deteriorate. The U.S., represented by Vice President Mike Pence, and China, represented by President Xi Jinping, exchanged barbs and couldn’t even agree on a non-binding statement at the conclusion of the meeting. I don’t expect anything constructive to come out of the Trump-Xi trade talks at the upcoming G20 meeting.
- Possibility of a U.S. government shutdown. Markets appear poised to sell off significantly if the U.S. government shuts down on December 7. While a shutdown seems unlikely at this juncture, the situation could change quickly – so we will want to follow it closely.
- Congress’ vote on the U.S.-Mexico-Canada Agreement (USMCA). There are concerns that the USMCA is in jeopardy, given rumblings that some members of Congress will oppose it for varying reasons. I think the USMCA will ultimately be passed, but some small alterations will likely be made in order to appease enough lawmakers.
- Falling oil prices. There continue to be concerns about lower oil prices. It looks like oil prices may remain lower for longer, which means investors need to contemplate the implications. For example, lower oil prices will have different implications for different countries, depending on whether they are oil-exporting or oil-importing. And lower oil prices, all else being equal, should ease cost pressures for the chemical industry, which uses oil as a key ingredient.
- The tech sector. The tech sector continues to come under very significant pressure, helped by growing concern that the sector – particularly the FAANG stocks – will come under greater regulation. I talked about this as a potential outcome from the midterm elections, and I believe it’s more likely than ever. However, it is not a reason for investors to abandon the tech sector, but instead could represent a selective buying opportunity.