These days the investing world seems split
between two types of market participants: the believers and the skeptics.
Firmly among the believers are investors in equity markets, which have
rebounded sharply from their sell-off in late 2018, supported by a dovish
pivot by the Federal Reserve, hopes of a trade-war truce between the U.S. and
China, and the U.S. government going back to work. Yet this rally, with the
S&P 500 up almost 20% since the low on December 24, has occurred even as
companies’ 2019 earnings have been revised markedly lower.
Moreover, while the equity market has rallied so far in 2019 (see Figure 1),
U.S. Treasury yields have declined, reflecting a skeptical view. Equities have
tended to benefit from falling yields increasing the present value of future
cash flows. Bond markets, however, have started to price a Fed rate cut within
the next 12 months, suggesting many investors see a downturn or recession in
the foreseeable future. And a recession isn’t good news for equity
markets: Historically, the U.S. stock market (S&P 500) has fallen an
average of 27% (peak to trough) during recessions.1
Recent data releases bolster the cautious economic outlook: They indicate the
global economy is slowing meaningfully, and many global growth forecasts have
been revised downward as well. This is not surprising to us as we’ve
expected a growing-but-slowing global economy for some time (see PIMCO’s
December 2018 Cyclical Outlook, “Synching Lower,” and May 2018 Secular Outlook, “Rude Awakenings”).
As one looks forward, what are markets telling us? This is where market
participants differ. The recovery in stocks suggests some have already bought
into better days ahead, while fixed income markets suggest others remain
China, the decider?
We will be discussing the near-term outlook for the global economy at our next
Cyclical Forum in March, in which PIMCO’s investment professionals from
around the world will gather in Newport Beach to debate key factors likely to
contribute to, or detract from, growth. We will publish our comprehensive
outlook on global markets and economies after the forum. For now I share a few
thoughts on China, which will be high on our list of factors to discuss for
several reasons, including the somewhat limited scope for upside surprises in
the U.S. and Europe over the next six to 12 months.
Chinese authorities have embarked on an enormous program of both monetary and
fiscal stimulus, which could lift market sentiment. For example, new credit
creation surged to a record high of 4.6 trillion yuan (CNY) in January (see
Figure 2), exceeding levels reached in 2015–2016 (albeit under the
People’s Bank of China’s old measure) as policymakers look to
stimulate the economy. Recent data out of China suggest that these measures
may be bearing fruit: Chinese New Year retail sales came in at +8.5%
year-over-year (yoy), January exports jumped 9.1% yoy and Chinese aggregate
credit creation grew 11% yoy (credit and export data from Bloomberg). Unlike
past Chinese approaches, which were more focused on demand (“shovels in
the ground”), this stimulus is supply side driven, so it’s hard to
know what the ultimate multiplier effect might be as there are no precedents.
In sum, the efficacy of the Chinese stimulus could be instrumental in deciding
whose views prevail: the believers or the skeptics. And if the believers are
right, emerging market equities – given their proximity to the stimulus
and current valuations – could be well-positioned to benefit.
For more on our asset class views for 2019, read our Asset Allocation
Late Cycle vs. End Cycle Investing.