Industry Voice: QMA's outlook and review for the final quarter of 2019

Economic Outlook

The global economy continues to be buffeted by the cross-cur­rents of US-China trade tensions and central banks' monetary easing. The trade standoff has taken a toll on business confidence, industrial production and trade flows. It has weighed heavily on global manufacturing and hit export-oriented economies the hardest. Fortunately, weakness in manufacturing has not yet dragged down the services sector, which remains resilient. The trade war also has less impact on more domestic-oriented econo­mies. As a result, there is a pronounced growth divergence among sectors and regions within the global economy.

Increased uncertainty from the US-China trade dispute is weighing on Japan's export outlook, with exports to China and the US remaining stagnant. The outlook for emerging markets also growth remains hostage to trade tensions. Trade and reduced consumption spending were drags on Eurozone growth, while investment spend­ing held up despite manufacturing confidence being in contraction territory. Brexit un­certainty continues to weigh on UK trade and business confidence gen­erally, and manufacturing confidence in particular.

With policy rates already at, near or below zero in many countries and negative interest rates having adverse unintended consequences for bank balance sheets, there are plenty of doubts about the ability of central bankers to ward off a downturn.

Investment Outlook

We see the potential for significant market swings between now and year-end. The clash between escalating geopolitical risks and additional monetary easing has fattened both the upside and downside risks for the global economy, and it is currently very difficult to deter­mine which force will gain the upper hand.

The key downside risk is a continued escalation of the trade war, which would lead to an even deeper downturn in global manu­facturing. This, in turn, could progressively weaken the healthier components of the global economy, namely the services sector and the US consumer, potentially triggering a broader global downturn.

Ultimately, the performance of the markets over the remainder of 2019 will depend on the answers we get to some critical questions. Will President Trump seek a détente with China as a way to protect the economic expansion ahead of the 2020 Presidential election, or will he double down on his current path of periodic escalation? Are the Chinese even willing to make substantive con­cessions if Trump changes his tune? Could a hard Brexit occur, sinking an already vul­nerable European economy? How will the Chinese government respond to continued violence in Hong Kong? Will the attacks on the Saudi oil fields spark a broader Middle East conflict? We still do not have high-conviction answers to these important questions.

The persistent economic and policy uncertainty described above argues against taking aggressive cyclical bets. Government bonds offer a safe haven and great diversification benefits but appear overbought and overvalued, assuming a global economic recession is not in the cards. Meanwhile, equity valuations are somewhat elevated relative to those of the past two decades. Nevertheless, the very depressed level of bond yields makes the relative valuation for equities quite attractive.

What would convince us to adopt a more bullish stance besides a reduction in policy uncertainty? The short answer is more definitive signs that global economic growth has bottomed and is starting to reaccelerate. A weaker trend in the dollar would also be encouraging. This would likely occur if the gap between US and non-US growth were narrowing, and it might show up before a de­cisive turn in the non-US economic data. German fiscal stimulus would also be a potential game changer depending on its size, but German policymakers still appear reluctant to act as they wait for evidence that the current downturn is more than just a technical recession. The recent inversion of the yield curve is admittedly a concern as yield curve inversions have preceded most recessions.  If the US were to falter and slide into recession, it would likely seal the deal on a global downturn, which is why the health of the US expansion is of critical interest to investors worldwide.

 

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NOTES TO DISCLOSURE

For Professional Investors only. All investments involve risk, including the possible loss of capital. Past performance is not a guarantee or reliable indicator or future results.

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The comments, opinions and estimates contained herein are based on and/or derived from publicly available information from sources that QMA believes to be reliable. We do not guarantee the accuracy of such sources of information and have no obligation to provide updates or changes to these materials. This material is for informational purposes and sets forth our views as of the date of this presentation. The underlying assumptions and our views are subject to change.

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