Quarterly review and outlook - BMO Global Asset Management
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BMO Global Asset Management THIRD QUARTER 2019
Market and Economic Insights
Quarterly review
and outlook
There’s politics and then there’s everything else Table of contents
Politics upstaged the global economy, monetary policy and even There’s politics and then there’s
everything else
trade tensions late in the third quarter as House Democrats began an
Slowing global growth: Should we
impeachment inquiry against President Trump. The inquiry followed a
be scared yet?
whistleblower complaint concerning phone calls between Trump and
The Fed hedges while the ECB
Ukrainian President Volodymyr Zelensky. These proceedings are likely to goes all in
dominate the U.S. media, consume Washington and seriously impede progress U.S. politics: Halloween horror
on bipartisan legislation, but we expect the immediate effects on financial show or just the usual circus?
markets to be less dramatic. Trade: Roadwork ahead but at least
the car is moving
Other storylines remain relevant even if they are elbowed out of the spotlight by political drama.
Positioning
As we note below, the U.S. economy has showed resiliency despite the slowdown in global growth,
a trade war with China and a volatile political environment. We expect this dynamic to continue
and have maintained our overweight to U.S. equities as a result.
Slowing global growth: Should we be scared yet?
The specter of recession continued to haunt investors in the third quarter as economic growth
indicators weakened further. Survey data showed manufacturing slowing across multiple economies
including Europe, the U.S. and emerging markets. In September, the Organization for Economic
Cooperation and Development downgraded its expectations for global growth across the G20
countries and emerging markets to the lowest levels since the financial crisis. China’s fiscal stimulus,
slowly rolled out over the last year, has not improved the situation as many had hoped, with
manufacturing there continuing to contract and the economy slowing further.
Yet the U.S. economy showed resiliency in this environment, in part because of the large role played
by consumer spending. Though President Trump has promised to restore America’s prominence as a
manufacturer, the reality is that manufacturing currently accounts for a relatively small percentage
(~11%) of U.S. output compared to countries like Germany (~30%). Consumption drives growth in the
U.S., and U.S. consumer spending remains strong.Market and Economic Insights Quarterly review and outlook THIRD QUARTER 2019 • PAGE 2
Contribution to percent change in real GDP
4
3
2
1
0
-1
-2
-3
2.3 2.2 3.2 3.5 2.5 3.5 2.9 1.1 3.1 2.0
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2
2017 2018 2019
Source: Bureau of Economic Analysis
In addition, purchasing managers’ indexes in the U.S. service sector have held up well, as they are
less vulnerable to trade tensions versus the manufacturing sector. With the housing market showing
signs of life due in part to lower mortgage rates, we expect U.S. leadership of the global economy
to continue. U.S. resiliency supports our position that fears of a major recession are overdone.
U.S. housing starts
Thousands (seasonally adjusted and annualized)
1,600
1,200
800 With the housing market showing
signs of life due in part to lower
mortgage rates, we expect U.S.
400
leadership of the global economy
to continue.
0
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Source: U.S. Census BureauMarket and Economic Insights Quarterly review and outlook THIRD QUARTER 2019 • PAGE 3
The Fed hedges while the ECB goes all in
In September, the Federal Reserve (Fed) cut interest rates for the second time this year. In an
effort to temper market reaction to the cut, the much-maligned phrase “mid-cycle adjustment”
was removed from the Fed’s official statement, though the commitment to “sustain the expansion”
remained. While the immediate response of the market was more muted, investors remain divided
on interpreting the latter comment, with a majority still anticipating two more cuts this year. The
Fed itself is increasingly fractured, with dissenters to the 25-basis-point September cut coming
from both hawkish and dovish perspectives. In part to illustrate the challenges in the current
environment, Chairman Powell alluded to the Fed’s laundry list of “reaction” functions, or global
crosscurrents to which the central bank responds. Some of these external factors are driving dissent Our expectation is that the Fed will
within the Fed, as some members are more concerned about Brexit risk and the manufacturing be a bit more U.S.-data dependent
slowdown in Europe. Our expectation is that the Fed will be a bit more U.S.-data dependent in in the fourth quarter, with just one
the fourth quarter, with just one more rate cut unless U.S. indicators take a sharp negative turn. more rate cut unless U.S. indicators
Meanwhile, the European Central Bank (ECB) held little back in Mario Draghi’s swan song as ECB
take a sharp negative turn.
president, announcing new quantitative easing, a cut to its main deposit rate and a tiered rate
system to help banks whose profits have been pinched by low interest rates. Emptying the toolkit
surely made it easier for Draghi to urge Europe’s governments to enact fiscal stimulus. His successor,
Christine Lagarde, is also on the record calling for fiscal stimulus. We expect Lagarde to continue
along the monetary-policy path Draghi has established; however, fiscal easing does not appear
imminent from the eurozone. Germany appears the most logical source of fiscal stimulus due to
their struggling economy coinciding with a fiscal surplus. However, Angela Merkel and her centrist
coalition have proposed only mildly stimulative measures primarily focused on green energy
projects and minor tax cuts. Contrary to the wishes of Mr. Draghi and Ms. Lagarde, it will likely
take a deeper downturn before larger-scale fiscal stimulus comes to the eurozone.
Percent of global negative yielding debt
Percent
35
30
Germany appears the most logical
25
source of fiscal stimulus due to
20 their struggling economy coinciding
with a fiscal surplus. However,
15
Angela Merkel and her centrist
10 coalition have proposed only mildly
stimulative measures primarily
5
focused on green energy projects
0 and minor tax cuts.
Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Sep
2014 2014 2014 2014 2015 2015 2015 2015 2016 2016 2016 2016 2017 2017 2017 2017 2018 2018 2018 2018 2019 2019 2019 2019
Source: BloombergMarket and Economic Insights Quarterly review and outlook THIRD QUARTER 2019 • PAGE 4
U.S. politics: Halloween horror show or just the usual circus?
The probability of impeachment spiked toward the end of the quarter as details around President
Trump’s call with the Ukrainian president hit the headlines. We expect impeachment hearings to
bring Congress to a virtual standstill, with the parties polarized and unlikely to pass bipartisan
legislation during the coming months. We believe the direct market impact from impeachment is
low but the secondary implications could cascade into trade discussions and the 2020 election field.
Odds of President Trump impeachment in 2019
70
60 We believe the direct market
50
impact from impeachment is low
but the secondary implications
40 could cascade into trade
30
discussions and the 2020
election field.
20
10
0
June 2019 July 2019 August 2019 September 2019
Source: PredictIt
Trade: Roadwork ahead but at least the car is moving
The U.S.-China trade war continues to loom over markets and the global economy. Market
participants seem so anxious for progress that they continue to overreact to any developments.
This has led to a volatile environment in which streaks of clarity alternate with a cloudier picture. In
August, both countries were in a retaliatory mood and announced new rounds of tariffs. Then China
dialed back the rhetoric and announced a desire to collaborate with a “calm attitude.” In September,
the U.S. exempted a slew of Chinese goods from tariffs imposed in 2018 as the Trump administration
The administration continues to
acceded to exclusion requests from U.S. entities. The administration continues, however, to play
play a high-risk game with tariffs
a high-risk game with tariffs as the effects of the policy creep closer to U.S. consumers. As we
as the effects of the policy creep
noted above, consumer spending drives U.S. growth and is one of the few remaining bright spots
closer to U.S. consumers.
in the global economy. Despite positive signs such as the tariff exemptions and China’s agreement
to increase agricultural purchases, we do not yet see any genuine progress toward resolving the
significant points of contention between the two countries such as intellectual property issues and
forced technology transfer. Our base case remains further de-escalation ahead of the 2020 U.S.
election but with little progress toward a large-scale deal that would address these issues.
While the heavyweight fight between the world’s two largest economies continues to dominate the
headlines, some other trade policy areas progressed in a more positive manner. There was genuine
momentum behind the effort to ratify the U.S.-Mexico-Canada (USMCA) trade agreement in the U.S.
and Canada, though the odds of near-term U.S. passage fell as impeachment gripped Washington.
Risks around U.S.-European trade tensions remain in the market — in particular around auto tariffs
— but notably both sides have carefully avoided escalation over the prior months.Market and Economic Insights Quarterly review and outlook THIRD QUARTER 2019 • PAGE 5
An in-person meeting between President Trump and Indian Prime Minister Narendra Modi at the end
of September also brought some optimism for progress on trade policy. A smaller-scale deal with
India, perhaps focused mostly on agricultural products, would help the Trump administration argue
that it is taking the steps necessary to eventually reach large-scale deals (i.e., in a second term).
Positioning
It is difficult to see a rebound for
In the third quarter, we removed our underweight duration position as the team’s these markets in the near term.
expectations for Fed rate cuts have shifted closer to market consensus. Combined with We expect U.S. equity earnings to
slowing economic growth, recession fears, a lack of inflationary pressures and trade strengthen over the remainder of
tensions, the Fed’s actions have made cash less attractive and provided support for core the year and exceed consensus
fixed income. In terms of equities, we remain underweight international developed- expectations, which have set a
market stocks due in part to weak manufacturing data and Brexit uncertainty. It is difficult relatively low bar.
to see a rebound for these markets in the near term. We expect U.S. equity earnings to
strengthen over the remainder of the year and exceed consensus expectations, which have
set a relatively low bar. An accommodative Fed and strong consumer further support our
overweight to U.S. equities.
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