Stock investors who are still riding high after the surge in US shares that has tripled in value from financial crisis lows are in for market tremors over the months ahead that they haven’t felt for years. As much as 20 per cent of that market could be erased over the next couple of months as stocks succumb to rising trade tensions around the world, the disintegration of over-hyped profit forecasts, a steep slide in economic growth, and political dissension, according to a detailed article in Business Insider by Vincent Deluard, director of global macro strategy at INTL FCStone.
What It Means for Investors
Two developments this past week are pointers that tensions between the world’s two largest economies are likely to weigh on the global economic outlook in the coming months. First, the Trump administration announced their intent to impose 10 per cent levies on an additional $300 billion worth of Chinese goods. Second, in response, China devalued the yuan and asked state-owned enterprises to halt purchases of US agricultural goods.
A long, drawn-out trade war appears to be in store, and that will knock too-rosy projections for corporate earnings, he believes. ‘Earnings are forecast to decline by 3.5 per cent next quarter, ahead of a miraculous rebound to 3.9 per cent in the fourth quarter,’ he said. ‘Besides a rapid settlement of trade tensions between China and the US (which seems unlikely in my view), I can’t see why the cyclical decline in US earnings should turn around this fall.’
Morgan Stanley strategists are also bearish on earnings projections. They predict that second quarter earnings for the S P will be down 1.2 per cent year-over-year and that the outlook will not improve. ‘Despite 2Q earnings “beating” their lowered bar, the outlook is not improving,’ the strategists wrote in a recent U S E quity Strategy report. ‘[S]ince6/30, 500 S and P earnings estimates have been falling across most sectors and in aggregate are down 1.8%/1.5% for3Q19/4Q19.
The slowdown in wages is not for nothing. Economic growth has been pretty much uninterrupted for more than 10 years, but in recent months signs of weakness pop out all over the place. Sputtering manufacturing activity, GDP and export growth have many wondering if a recession is not far off. At this point, more easing from the US Federal Reserve won’t avert it.
Such political tensions are rising, too. A hard Brexit seems more likely than ever, tensions with Iran are rising, and the race for the US presidential election is bound to superheat political polarisation, which could easily destroy what little positive economic sentiment remains.
Deluard isn’t the only one predicting a correction later this year; a recessionary warning emitted by one of the financial markets’ most respected harbingers flashed its brightest red light since 2007 last week. Since last spring, rates paid by a 10-year Treasury note have been lower than they are for a 3-month Treasury bill. On Monday though, the negative difference between the two increased to its widest spread since prior to the 2008 financial crisis, according to Bloomberg.
An alarm sounded most recently by David Rosenberg, chief economist and strategist at Gluskin Sheff, who argued that a Federal Reserve-created corporate-debt bubble could well be prime to tip the economy into the next recession. ‘My thesis all along has been that this will be a capital spending-led recession,’ he said. ‘We’re going to be finding a lot of the cash flows being diverted to debt service – even under this low interest rate environment – away from capital spending.
Looking Ahead
That said, Deluard still sees good things down the road when the market finally bottoms, including a falling US dollar, rising yields, gains in emerging markets and a rebound in value and cyclical stocks. The world will be a far rougher one to live in if the US‑China trade relationship gets even worse than it already is.