Notes on the Week Ahead

Transcription

1 Notes on the Week Ahead January 28, 2019 Dr. David P. Kelly, CFA Chief Global Strategist Labeling the Boxes With age comes wisdom and one bit of wisdom my wife and I have acquired over the years is that, when moving residence, you need to accurately label the boxes. Nothing is more disheartening than a mountain of random unlabeled cardboard containers when you are trying to reestablish order in the wake of chaos. In a similar fashion, investors this week have a lot to unpack in understanding the economic implications of the government shutdown, the peak of the earnings season, the January employment report, Chinese trade talks, weakening global PMIs and the first Fed meeting of the year. So in the interests of clarity, I thought I would go through these boxes one by one, starting with what I think is an appropriate label: Box #1: The Government Shutdown labeled as An early landing on a long runway On Friday, the President signed a bill funding the federal government through February 15 th and ending, on its 35 th day, the longest government shutdown in history. Over the next few weeks, a bipartisan committee of senators and representatives will try to hammer out a compromise. This should not, in the end, be that difficult since both sides agree on the need for border security and neither side would want to be blamed for an encore of the last five weeks. The full cost of the shutdown is difficult to assess. The 380,000 federal workers who were furloughed represent 0.25% of America s 150 million payroll employees. Our GDP is currently roughly $21 trillion so losing 0.25% of it for 5 weeks would amount to a cost of roughly $5 billion. However, the actual impact was likely multiple times that. First, there is the spending not done by the 800,000 federal workers who went without paychecks. Even with back pay, some of this spending will be lost for good as will the work and spending of many federal government contractors that were also laid off. Moreover, the most disruptive element of the shutdown was its negative impact on confidence, (which will likely show up in Tuesday s Consumer Confidence Survey) and the uncertainty it created, which likely postponed important business decisions.

2 All told, we had expected the economy to gradually slow from 3% real GDP growth in 2018 to 2% growth in the second half of However, (as best we can tell, hampered by a lack of government data), this slowdown may now kick in a little earlier, with growth averaging 2.0% over the fourth and first quarters combined. It should be noted, however, that in the absence of other shocks, it should be possible to maintain this roughly 2% average growth pace well into 2020 and perhaps beyond. Box #2: The Jobs Report labeled as Continued momentum despite shutdown distortions Friday s Jobs report will be complicated and distorted but ultimately should show continued strength. Even without a government shutdown, this would have been a difficult report to interpret since the data for January each year contain both population adjustments to the household survey (from which the unemployment rate is derived) and benchmark revisions to the payroll survey. In addition, 800,000 workers were either on furlough or working without pay during the employment survey week in January (which ran from January 6 th through January 12 th). Of this total, the 420,000 working without pay will have been counted as employed by both surveys. However, the 380,000 federal workers on furlough should show up as unemployed in the household survey. In addition, there will have been some employees of federal contractors who would have been at least temporarily unemployed. However, the job market reacts with a lag to economic growth and, due to strong growth through at least the third quarter of last year, we expect the January employment report to still show some momentum, with close to 200,000 jobs added and the unemployment rate only temporarily halted on its downward track. Box #3: The Earnings Season labeled as A predictable moderation in growth Through last Thursday, 106 S&P500 companies had reported earnings for the fourth quarter with another 126 firms set to report this week. Overall, the earnings season has been weaker than in recent quarters. We now expect a 16% year-over-year gain in operating EPS for the fourth quarter which, although impressive by historical standards, represents a significant drop from the 29% average gain seen in the first three quarters of In addition, positive surprises in both revenues and earnings are running at their lowest levels in six quarters and eight quarters respectively. There may be a little bit of kitchen sink accounting here, whereby companies use accounting flexibility to bury bad news in the last quarter of the old year in order to make it easier to report strong gains going forward. However, analysts will increasingly be watching expectations of 2019 earnings, since a slide from slower earnings growth to outright decline at any stage in 2019 or 2020 would be bad news for both the markets and the economy. Box #4: Global PMIs labeled as A little bit softer now Friday s purchasing manager data from around the world will give an early read on global economic activity at the start of 2019 and the picture is likely to be downbeat. The Eurozone manufacturing flash PMI fell to a 67-month low in January, with weakness in Germany swamping a partial rebound in the French numbers. The Eurozone is still expanding, as should be confirmed by numbers on 4 th -quarter GDP and December unemployment due out this week. However, trade tensions, political instability and a host of negative one-time factors have slowed economic growth to a crawl. 2

3 Japan s flash manufacturing PMI was also weak in January falling to exactly 50.0, its lowest level since August Friday s releases will likely show below-50 readings in China, Korea and Taiwan, reflecting a downturn in global trade. As in the case of Europe, this is, for now, just very slow growth rather than recession. However, the broad weakness in the global economy, which could also show up in low readings in Canada and Mexico, highlights the importance of reducing geopolitical and trade uncertainty. Box #5: Chinese Trade Talks labeled as Progress likely but no deal before the deadline A Chinese delegation will be in Washington this week to discuss trade issues. The U.S. Administration has demanded structural changes in China s economic model to reduce the U.S. s mammoth trade deficit with China. While both sides have a strong interest in coming to an agreement, no one should be under any illusion that a deal will fundamentally change the trajectory of either economy. China may well reform its strong-arm tactics with regard to transfers of intellectual property and tone-down its Made in China 2025 rhetoric. However, it remains committed to technological transformation and is probably well positioned to achieve this, even with less access to foreign R&D. The U.S. may also see its trade deficit with China fall. However, this will likely be replaced by bigger trade deficits with other nations, as the ultimate drivers of the U.S. trade deficit are a growing budget deficit and a high U.S. dollar, neither of which show near-term signs of declining. That being said, this week s talks will likely be described as tough with no breakthrough. Both sides will want to be seen as having fought a tough fight and negotiations will likely extend to the March 1 st deadline for the imposition of higher U.S. tariffs on Chinese goods. One more month of uncertainty will clearly do the global economy no good, but an agreement, if achieved at that point, would be a big positive for global markets. Box #6: Fed Policy labeled as A challenge in communications Finally, the Federal Reserve will hold its first FOMC policy meeting of the year on Tuesday and Wednesday followed by a statement and a Jay Powell press conference. While the committee is not expected to take any action at this meeting, the statement and press conference will need to be handled very carefully if they are to get their message across correctly. The statement will likely strike a more dovish tone than the last FOMC statement on December 19 th. It will likely acknowledge the increased uncertainty in the economic outlook due to the government shutdown and the lack of many key economic reports in recent weeks. It will probably also comment on a somewhat softer inflation outlook due to recently lower oil prices and the increased volatility in markets in recent months. In his press conference, Jay Powell will likely make the case for not raising the federal funds rate in March, marking the first pause in quarterly monetary tightening since September He will likely emphasize that the Fed is not particularly concerned about a near-term recession but rather recognizes that they are likely close to a neutral rate and that, given current uncertainties, it makes sense to hold off on further tightening for now. He will probably reassert that any more dovish stance by the Fed is in reaction to changing financial conditions rather than any political pressure. 3

4 Chairman Powell may well also be asked about the Fed s balance sheet reduction program which has now reduced the total assets of the Fed by $408 billion since it commenced in October of He will, very likely, confirm that the program will continue for some time to come. However, he may want to emphasize that, if it is ended faster than initially anticipated, it would be neither a capitulation to political pressure or a sign of a more dovish policy overall but rather because the banking system is seeing its reserves fall at the Fed faster than anticipated. This is certainly the case the excess reserves held by U.S. banks at the Federal Reserve, (that is to say reserves in excess of those needed to back deposits), have fallen from a peak of $2.702 trillion in August of 2014 to just $1.524 trillion today and continue to fall much faster than the Fed s assets. The reason for this is that excess reserves are just one line item on the liability side of the Fed s balance sheet and faster growth in other line items, most notably currency in the hands of the public, has squeezed excess bank reserves. In the long run, given its new operating procedure of trying to maintain the federal funds rate in a band, the Fed doesn t want these excess reserves to fall back to pre-crisis levels. However, it is a complicated story and explaining this, without appearing to send an unintended signal to markets, will be a very delicate task for Mr. Powell. For investors, all of this needs to be balanced against valuations that still look relatively attractive for U.S. stocks and even more so for international stocks. In addition, in the months ahead some of these uncertainties should be resolved and as they are, markets could turn somewhat more positive. As is the case when unpacking boxes, while the work is tiring now, there are reasons to look forward to a day when the environment is both clearer and more comfortable. 4

5 The Market Insights program provides comprehensive data and commentary on global markets without reference to products. Designed as a tool to help clients understand the markets and support investment decision-making, the program explores the implications of current economic data and changing market conditions. For the purposes of MiFID II, the JPM Market Insights and Portfolio Insights programs are marketing communications and are not in scope for any MiFID II / MiFIR requirements specifically related to investment research. Furthermore, the J.P. Morgan Asset Management Market Insights and Portfolio Insights programs, as non-independent research, have not been prepared in accordance with legal requirements designed to promote the independence of investment research, nor are they subject to any prohibition on dealing ahead of the dissemination of investment research. This document is a general communication being provided for informational purposes only. It is educational in nature and not designed to be taken as advice or a recommendation for any specific investment product, strategy, plan feature or other purpose in any jurisdiction, nor is it a commitment from J.P. Morgan Asset Management or any of its subsidiaries to participate in any of the transactions mentioned herein. Any examples used are generic, hypothetical and for illustration purposes only. This material does not contain sufficient information to support an investment decision and it should not be relied upon by you in evaluating the merits of investing in any securities or products. In addition, users should make an independent assessment of the legal, regulatory, tax, credit, and accounting implications and determine, together with their own professional advisers, if any investment mentioned herein is believed to be suitable to their personal goals. Investors should ensure that they obtain all available relevant information before making any investment. Any forecasts, figures, opinions or investment techniques and strategies set out are for information purposes only, based on certain assumptions and current market conditions and are subject to change without prior notice. All information presented herein is considered to be accurate at the time of production, but no warranty of accuracy is given and no liability in respect of any error or omission is accepted. It should be noted that investment involves risks, the value of investments and the income from them may fluctuate in accordance with market conditions and taxation agreements and investors may not get back the full amount invested. Both past performance and yields is not a reliable indicator of current and future results. J.P. Morgan Asset Management is the brand name for the asset management business of JPMorgan Chase & Co. and its affiliates worldwide. This communication is issued by the following entities: in the United Kingdom by JPMorgan Asset Management (UK) Limited, which is authorized and regulated by the Financial Conduct Authority; in other EEA jurisdictions by JPMorgan Asset Management (Europe) S.à r.l.; in Hong Kong by JF Asset Management Limited, or JPMorgan Funds (Asia) Limited, or JPMorgan Asset Management Real Assets (Asia) Limited; in Singapore by JPMorgan Asset Management (Singapore) Limited (Co. Reg. No K), or JPMorgan Asset Management Real Assets (Singapore) Pte Ltd (Co. Reg. No E); in Taiwan by JPMorgan Asset Management (Taiwan) Limited; in Japan by JPMorgan Asset Management (Japan) Limited which is a member of the Investment Trusts Association, Japan, the Japan Investment Advisers Association, Type II Financial Instruments Firms Association and the Japan Securities Dealers Association and is regulated by the Financial Services Agency (registration number Kanto Local Finance Bureau (Financial Instruments Firm) No. 330 ); in Korea by JPMorgan Asset Management (Korea) Company Limited; in Australia to wholesale clients only as defined in section 761A and 761G of the Corporations Act 2001 (Cth) by JPMorgan Asset Management (Australia) Limited (ABN ) (AFSL ); in Brazil by Banco J.P. Morgan S.A.; in Canada for institutional clients use only by JPMorgan Asset Management (Canada) Inc., and in the United States by JPMorgan Distribution Services Inc. and J.P. Morgan Institutional Investments, Inc., both members of FINRA/SIPC.; and J.P. Morgan Investment Management Inc. In APAC, distribution is for Hong Kong, Taiwan, Japan and Singapore. For all other countries in APAC, to intended recipients only. Copyright 2019 JPMorgan Chase & Co. All rights reserved 0903c02a820bc602