Second-half outlook: Could central bank dovishness help stocks take flight?
Second-half outlook: Could central bank dovishness help stocks take flight?
How will central-bank activism and trade tensions affect global assets in the second half of the year? Invesco’s Global Market Strategy Office explains.
The first half of 2019 was characterized by two key themes that I have been discussing for a while — central bank activism and trade wars — and I expect these themes to shape the path ahead for the second half as well. My expectation is for risk assets to outperform non-risk assets, and for the economic expansion to continue — but more slowly. However, trade wars carry the potential for danger, so we are watching closely for signs that the slowdown may be turning into a recession.
Trade talks stumbled in the first half
In the first half of the year, conventional wisdom suggested that the US and China would act rationally and arrive at a trade agreement, so we believed there was no reason to worry. And trade talks seemed to be going just fine for much of 2019, according to reports from both China and the US.
But I was worried, as I believed there was a mismatch in expectations, that China felt it could just narrow the trade deficit and the US would be satisfied, while the hawks in the Trump administration seemed far more focused on intellectual property rights and access to markets. I couldn’t find a compelling reason why China would make major concessions to the US, given that it had the ability to play a “long game” that the US could not.
When trade talks broke down in early May, most market participants were very surprised, and stocks sold off.
Will the Fed cut rates in the second half?
Major central banks took notice. Many had moved to a more dovish stance at the start of 2019, but that began to deepen when trade talks broke down in May and market participants began to anticipate more accommodation. At its June meeting, the Federal Reserve clearly telegraphed that it will no longer be “patient” and that it is leaning towards loosening monetary policy:
- “… the case for somewhat more accommodative policy has strengthened,” Fed Chair Jerome Powell said at his press conference following the June meeting.1
- Fed Vice Chair Richard Clarida explained in an interview, “There was, I think, broad agreement around the table that the case for providing more accommodation has increased since our May meeting.”2
Powell provided a rationale for the Fed’s growing dovishness during his press conference: “It’s really trade developments and concerns about global growth that are on our minds. Risks seem to have grown.”3 And the risk of trade wars is what we have been warning about for several years now. Powell pointed to the fact that uncertainty has increased, and business investment is slowing. As I have warned, economic policy uncertainty has historically depressed business investment, and it seems that history is repeating itself yet again. Minneapolis Fed President, Neel Kashkari, has recently argued that the Fed should cut interest rates by half a percentage point in order to reanchor inflation expectations.4
Global central banks may loosen policy as well
The Fed is not alone. European Central Bank (ECB) President Mario Draghi suggested last week that the ECB would be open to introducing new stimulus measures. Ditto for the Bank of Japan. And while the Bank of England has been sounding a more hawkishtone, it cut its growth forecast for Britain’s economy to zero in the second quarter and highlighted risks from global trade tensions and growing fears of a no-deal Brexit, suggesting it might need to get more accommodative.
The result has been that the universe of negative-yielding sovereign bonds has recently grown to approximately $13 trillion, according to Bloomberg.5 However, this phenomenon is not limited to government debt. Bloomberg also reported that nearly a quarter of investment grade credit is now negative yielding as well.5
My outlook for the second half of 2019
Central banks’ dovish turn is shaping my outlook for the back half of 2019:
- I expect slower growth globally, especially given that I don’t see an end to the trade wars.
- I expect greater volatility given that geopolitical risks are rising.
- However, I believe significant central bank accommodation should not only keep the US and other major economies from going into recession, but should cause, in general, risk assets globally to outperform non-risk assets.
- We also must recognize the continued need to find diversified sources of income in this persistently low-rate environment.
Below, I highlight my second-half outlook for each region, developed with my colleagues in Invesco’s Global Market Strategy Office:
US. We expect the economy to decelerate very modestly in the back half of this year, supported by Fed accommodation, which should benefit US equities. Given that rates will be lower for longer, I believe institutional investors should consider a greater allocation to a variety of fixed income sub-asset classes, including some further out on the risk spectrum, including investment grade credit, municipals and other higher yield fixed income asset classes, as well as dividend-paying stocks.
Eurozone. We expect a continued, modest deceleration in the eurozone economy in the next few months. We have concerns that the next ECB president — who will begin his or her term in November — may be more hawkish and accelerate a slowdown in the eurozone. And because the ECB may not be accommodative enough, we are cautious about eurozone equities in the next six months. In this low-rate environment, we believe exposure to eurozone investment grade and high yield credit makes sense. In addition, eurozone real estate looks most attractive, in our view, given its yield generation and diversification qualities. We are also cautious on UK equities in the near-term, given so much uncertainty — and given that the Bank of England does not appear ready to provide more accommodation.
Japan. We expect modest improvement for the economy. With valuations attractive for Japanese equities, and the Bank of Japan looking for ways to provide more accommodation, we are slightly positive on Japanese equities.
Emerging markets. In this environment, we are positive on emerging markets. In general, emerging markets (EM) economies are likely to benefit from more Fed accommodation, especially the end of balance sheet normalization. However, we recognize some emerging economies could be negatively impacted if the trade war worsens and the economic slowdown accelerates. Therefore, we are positive on EM equities, but we believe institutional investors need to be selective as some EM markets may not fare well given growing geopolitical risks. In terms of China, we expect its economy to maintain growth at the 6% – 6.5% level. That’s because we belive the government is doing a good job in terms of providing stimulus to its economy. We recognize that Chinese monetary growth has been lackluster despite this level of stimulus. However, looking at metrics such as loan growth and rail freight suggests growth is solid. In addition, we are also seeing more flows into Chinese equities because of greater inclusion in some MSCI indexes.
In this environment, we believe the bias is towards risk asset outperformance. However, we recognize the dangers that trade wars pose, especially to a global economy that is already slowing. Therefore, we are following recession indicators closely, recognizing that we need to be ready to tactically shift portfolios with shorterterm time horizons if compelling signs of a recession appear. Looking ahead, we will be vigilant in terms of watching for signs that the slowdown turns into a recession. However, at this juncture, we expect the economic expansion to continue — albeit more slowly.
Kristina Hooper is Chief Global Market Strategist at Invesco.
^1 Source: Bloomberg L.P., “Fed scraps patient approach and opens door to potential rate cut,” June 19, 2019
^2 Source: Bloomberg TV interview, cited in The Wall Street Journal, “Fed’s Richard Clarida: ‘We’ll act as appropriate to sustain expansion,’” June 21, 2019
^3 Source: Washington Post, “US markets mixed amid Iran tensions, G-20 anticipation,” June 21, 2019
^4 Source: Federal Reserve Bank of Minneapolis, “A strategy to re-anchor inflation expectations,” Neel Kashkari, June 21, 2019
^5 Source: Bloomberg L.P., “The world now has $13 trillion of debt with below-zero yields,” June 20, 2019
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The opinions referenced above are those of Kristina Hooper as of July 9, 2019.
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