By Gary Stringer, Kim Escue and Chad Keller, Stringer Asset Management
Though the economic and market headlines are full of interesting narratives, it is important to look past the superficial to understand the underlying fundamentals in order to get a sense for what we can expect beyond the day-to-day noise. While the headlines continuously change, economic and market fundamentals remain the driving force for global markets. As we navigate the road ahead we look to three likely characteristics to guide us.
First, we expect the global economy to continue advancing as long as the underlying fundamentals remain strong. Overall, the indicators that we track suggest optimism for the global economy and risk assets, such as equities and commodities, so we think investors should maintain these exposures consistent with their overall plan.
Secondly, we expect economic growth to slacken from its blistering pace at the end of 2017 as some of the recent positive economic reports are likely to come back down to normal levels.
For example, the latest ISM Manufacturing Index reading of 60.8 suggests real U.S. GDP growth of approximately 4.0%. This growth rate is roughly double the sustainable rate estimated by the U.S. Federal Reserve (the Fed). Furthermore, the ISM New Orders Index, which tends to lead business investment, and the NFIB Small Business Optimism Index are nearing all-time highs (exhibit 1). Based on history, both of those indicators are likely to fall back rather than remain at lofty levels for long periods of time.
Broad economic growth is likely to soften globally, not just in the U.S. economy. For instance, the recent Markit Eurozone Manufacturing PMI survey suggests the European manufacturing sector is performing at one of its fastest paces in over 20-years (exhibit 2).
However, among the components in the survey, the growth of new orders, output and backlogs of work eased from prior readings. Additionally, factory output grew at its slowest percentage in four months.
The rate of economic growth in China should soften as well. After years of encouraging debt-fueled investments domestically and overseas through its Go Out policy, China seems to be curtailing its reliance on debt and the risks associated with that type of economic growth. For example, they initially increased restrictions on the financial services sector and more recently nationalized the Anbang Insurance Group, which was struggling under a large debt burden and posed risks to their domestic customers. This suggests to us that China’s government is getting serious about protecting the country from a financial crisis and reducing their economic growth to a more sustainable rate.
Finally, some of the side effects of economic deceleration are likely to be volatile stock and commodity markets with somewhat higher bond prices and lower long-term interest rates in the near-term.
Since the U.S. economy has been growing at a pace above what the U.S. Federal Reserve (the Fed) considers the long-term potential growth rate, we are closely following the evolution of Fed policy as economic growth slows. The Fed is expected to increase short-term interest rates on March 21, with the market projecting at least three 0.25% interest rate hikes this year. In general, rate hikes by the Fed tend to be deflationary, or at the very least, soften potential inflationary pressure and cause long-term interest rates to decline. In addition, slowing global economic growth momentum should also result in declining long-term interest rates.
During the 2000s, the 10-year Treasury yield has averaged less than nominal GDP (NGDP) growth. As we expect NGDP growth to slip back towards the 4.0% area, we think the 10-year Treasury yield will fall back to the 2.5% area (exhibit 3).
Our trigger finger is itchy as we watch the responses from the Fed and other central banks to the shifting economic environment. Our base case is that the Fed will not make a major mistake, which should allow the global economy to continue to grow. Economic growth leads to increase corporate revenue and earnings, which can ultimately support higher stock prices. We are prepared for more volatility and have shifted our Strategies to benefit from what we think will be a bumpy road to higher equity prices from here.
This article was written by Gary Stringer, CIO, Kim Escue, Senior Portfolio Manager, and Chad Keller, COO and CCO at Stringer Asset Management, a participant in the ETF Strategist Channel.
DISCLOSURES
Any forecasts, figures, opinions or investment techniques and strategies explained are Stringer Asset Management, LLC’s as of the date of publication. They are considered to be accurate at the time of writing, but no warranty of accuracy is given and no liability in respect to error or omission is accepted. They are subject to change without reference or notification. The views contained herein are not to be taken as advice or a recommendation to buy or sell any investment and the material should not be relied upon as containing sufficient information to support an investment decision. It should be noted that the value of investments and the income from them may fluctuate in accordance with market conditions and taxation agreements and investors may not get back the full amount invested.
Past performance and yield may not be a reliable guide to future performance. Current performance may be higher or lower than the performance quoted.
The securities identified and described may not represent all of the securities purchased, sold or recommended for client accounts. The reader should not assume that an investment in the securities identified was or will be profitable.
Data is provided by various sources and prepared by Stringer Asset Management, LLC and has not been verified or audited by an independent accountant.