Weekly Investment Commentary: Capital markets will likely be choppy
- U.S. economic data has softened slightly, but global data is generally improving.
- Escalating concerns over the coronavirus have dampened the reasonably hopeful investment backdrop at the beginning of the year.
- Cyclical economic conditions are poised to improve only modestly this year, and any upturn may be delayed by the impact of the virus, especially in China.
Equities finished lower for a second straight week, with the S&P 500 Index down 2.1% and suffering back-to-back weekly declines of more than 1%for the first time since late August.1 Energy was the worst performer for a fourth straight week as growth concerns stemming from the coronavirus weighed heavily on oil. Outsized weakness in industrial metals, chemicals, paper and packaging put pressure on Materials. Utilities performed best, as defensive sectors tended to fare better. Consumer discretionary also finished positive for the week, thanks to strong earnings from Amazon.
Weekly top themes
- It appears that fourth-quarter earnings will end up positive by 2 to 3%, with nearly half of S&P 500 companies reporting. The expected growth rate for 2020 now stands at 9.1%, down from 9.4% earlier in the year. Our guess remains plus 6%. Most companies have indicated the macro backdrop is healthy and have viewed the phase-one trade deal as a modest positive on margins.
- Real GDP beat expectations, increasing 2.1% quarter-over-quarter and 2.3% year-over-year. Capex was down 1.5%, but tech capex increased 6%.2
- The period since the December Fed meeting has been dominated by three developments: 1) softer U.S. data but generally better global data, 2) an extension of the fourth quarter market “melt up” that triggered Fed unease that balance-sheet expansion may be fueling risk-taking and 3) the coronavirus that drove a swing back to risk off. It is too soon to tell how serious the economic impact of the virus will be, but it could put a short-term drag on Chinese growth that would weigh on global stabilization.
- The combination of very low put-call ratios, aggressive ETF flows and widespread overbought conditions posed a tactical risk for markets. However, a spark to catalyze a correction was missing. While the Iranian situation quickly faded and impeachment hasn’t hit bullish sentiment, the sudden emergence of the coronavirus appears to have struck at the foundation of the market’s upturn.
- Last year’s decline in mortgage rates has helped generate a meaningful recovery in the housing market. Provided long-term interest rates rise in an orderly manner, housing’s recovery should persist and provide a basis to extend the economic expansion. Importantly, a recession has never started while housing has been expanding.
- We expect global manufacturing to pick up in 2020, thanks to the delayed tailwind from the synchronized global easing cycle that pushed global short rates to a new expansion low. Unfortunately, the coronavirus is a new, potentially significant headwind that is impossible to forecast.
- House Democrats released an infrastructure plan. While it has little chance of becoming law before the election, it provides guidance on what Democrats might do if they win in November.
Concerns over the coronavirus dampen investor sentiment
The investment backdrop at the start of the year was reasonably hopeful. Closely watched manufacturing indicators pointed to a potential cyclical uptrend after a two-year slowdown. Monetary policy was highly accommodative and destined to stay that way, at least through the U.S. election in November. Prior political and policy concerns had abated, with the U.S./China phase-one trade agreement, the decisive outcome of the U.K. election and somewhat diminished anxiety about a U-turn in economic policy after the results of the upcoming U.S. election.
However, the escalation of the coronavirus has detoured these positive developments. It’s unclear how the health crisis in China will evolve, but investors will remain jittery until the virus is contained. That said, risk assets were overheated by mid-January and vulnerable to any negative news. We caution reading too much into investors’ reactions so far. A further global equity correction of 3% to 5% would still leave the underlying uptrend intact.
While we optimistically assume the coronavirus will soon be contained, markets were overdue for a reality check. Cyclical economic conditions are poised to improve only modestly this year and signs of an upturn may be delayed by the impact of the virus, especially in China. Equity and credit valuations are already full by historical standards following major rewritings in 2019.
The U.S. election remains a wild card, and there’s potential for setback as the U.S., China and U.K./ EU strategic relationships are negotiated. Our base-case scenario continues to call for choppy capital markets this year. By mid-January, markets had already discounted much of 2020’s anticipated economic and earnings improvement. So resetting expectations was due. Present and anticipated conditions do not warrant aggressive positioning until we see more clarity or more attractive valuation entry points.
Present and anticipated conditions do not warrant aggressive positioning until we see more clarity or more attractive valuation entry points.
1 Source: Bloomberg, Morningstar Direct and FactSet
2 Source: Credit Suisse
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