A Hit to Q1 Growth
Global business activity is taking an unexpected hit from worries over the coronavirus outbreak, according to recent data from IHS Markit. As the chart below shows, the IHS Markit purchasing managers’ index fell sharply through mid-February with U.S. Services Business Activity Index falling to 49.4 (53.4 in January), a 76-month low. The IHS Manufacturing Survey (below) also fell to 50.8 (51.9 in January), a 6-month low. New orders fell for the first time since data collection began in 2009.
Hesitancy among firms due to coronavirus is causing a decline in business activity in the United States. This is the conclusion reached by IHS Markit’s economist in reaction to the surveys mentioned above. Chris Williamson, Chief Business Economist at IHS Markit, said: “Manufacturing production ground almost to a halt due to a near-stalling of orders.” He went on to say that the survey data was consistent with a 0.6% pace of GDP growth in February, down from 2% in January. Somewhat counterintuitively, he also said that business sentiment about the year ahead saw a notable upturn, reflecting “widespread optimism that the current slowdown will prove short-lived.”
The Test for Bulls
For the bullish case for stocks to stay intact, it is important that business confidence remains firm. To see a pickup in earnings to support higher valuations, businesses confidence and capital spending will need to see a boost. The downtrend in global activity in 2019, exhibited in the chart above, halted in the back half of last year. Monetary easing, a trade truce, and leaner inventories set the stage for a sustained upswing at the start of the year. However, two new wildcards — coronavirus and uncertainty over the U.S. election — pose risks to this outlook. A relapse into contracting business activity or a darkening profit outlook would make the bull case for equities a harder one to advance.
Safe Assets Rally
Another record low was set last year for long-term U.S. Treasury bond yields (charts, above left). The 30-year U.S. Treasury bond fell to yield near 1.9% last Friday after two strong days of gains in the bond market. Never before has the long bond carried such a low yield. The 30-year inflation rate priced into inflation-protected Treasury bonds is only 1.7%, implying that the market is priced to realize just a 0.2% real return for holding the most extended end of the Treasury yield curve. Also, the spread between 10-year U.S. Treasury yields and 3-month Treasury bills again turned negative last week and ended the week at -7 basis points (-0.07%). As we discussed last summer, this “inversion” or negative spread is often seen as a harbinger of slowing growth or recession.
As bonds have rallied, so too has gold (chart, above right). Gold is up 26% since last June versus a 22% gain in the S&P 500 (a large-cap U.S. equity market index). The rise in gold and jump in Treasury prices can mean that investors are seeking “insurance” or “safe” assets. Such run-ups are not uncommon during uncertain times but can reverse course violently once the proximate cause of market jitters fade.
The last week’s market action and dataflow did little to advance a bullish case and suggest worries over the coronavirus will likely hurt near-term growth. A bigger question remains: will business confidence continue to hold up despite the coronavirus outbreak and jitters surrounding upcoming U.S. elections. If confidence does hold up, the hit to growth could prove short-lived and be followed by a sharp second-half rebound.
Kevin Caron, CFA, Senior Portfolio Manager
Chad Morganlander, Senior Portfolio Manager
Matthew Battipaglia, Portfolio Manager
Steve Lerit, CFA, Client Portfolio Manager
Suzanne Ashley, Analyst
WCA Fundamental Conditions Barometer Description: We regularly assess changes in fundamental conditions to help guide near-term asset allocation decisions. The analysis incorporates approximately 30 forward-looking indicators in categories ranging from Credit and Capital Markets to U.S. Economic Conditions and Foreign Conditions. From each category of data, we create three diffusion-style sub-indices that measure the trends in the underlying data. Sustained improvement that is spread across a wide variety of observations will produce index readings above 50 (potentially favoring stocks), while readings below 50 would indicate potential deterioration (potentially favoring bonds). The WCA Fundamental Conditions Index combines the three underlying categories into a single summary measure. This measure can be thought of as a “barometer” for changes in fundamental conditions.
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