Stronger Survey Data Quashes Recession Fears For Now

Equity market sentiment has performed a sharp U-turn in recent weeks. Above-consensus purchasing manager’s (PMI) data in China and the US has for now at least quashed earlier concerns of a US recession. We are encouraged by the recent improvement in the data, which is arriving a little ahead of our earlier expectations of around mid-2019. In addition, US/China trade talks appear to be making some further progress and may now be down to details, albeit important ones, even if the timing of any US/China Presidential summit remains uncertain. In the meantime and importantly for equity markets, consensus earnings estimates for 2019 now appear to have stabilized.

It seems that only a few days ago we were discussing the correlation between the inversion of the US yield curve and the likelihood of a US recession. We argued against the idea that the US yield curve was indicating an imminent US recession, as the inversion was driven by policy easing. A mini-crisis in market confidence as bond yields fell has since given way to a further move higher in global equities, led by China’s stock market which is now up over 30% year-to-date.

The quarter-long rally in global equities has in our view been driven by an unwind of risk premia relating to:

  • Fear of overly tight US monetary policy
  • Declining global GDP growth expectations for 2019
  • Risk of a US recession in 2020;
  • Fading prospects for 2019 earnings growth;]
  • US-China/trade negotiations
  • Brexit.

By the end of 2018, the combination of these factors had pushed developed market equities to a 3-year low in valuation terms, a relatively attractive level in hindsight given the likelihood that the US Fed and ECB would indeed respond to evidence of a loss of economic momentum and loosen policy.

It would be easy to understate the scope of the shift in US Fed policy given its rapid implementation. It was only a few months ago that the US Fed was perceived to be monotonically raising interest rates and reducing the size of its balance sheet, with a predictable funding squeeze taking place not only in the US but also in emerging markets. Pleas from EM central bankers for the Fed to go on pause were largely ignored during 2018. Now, market-implied rates indicate that the peak in US interest rates may already have been reached in this cycle and Fed’s balance sheet reduction has been halted.

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