Is the bad news priced in?

Financial markets have been driven largely by five factors over the recent year. Considering these drivers of recent market behavior, I see a significant possibility that the market is overly pessimistic about the outlook.

The five market drivers are:

  1. Slowing US economic growth. Growth has been steadily slowing since the middle of 2018 as the boost from fiscal stimulus has come out of the system. Invesco Fixed Income still believes US economic growth is migrating back toward its potential rate of around 1.8%, but that stabilization has not stopped the market from being concerned about the overall slowing growth trajectory.1 Slowing US growth has been a negative headwind for other countries and contributed to the global growth slowdown across developed market (DM) and emerging market (EM) countries.
  2. Global economic policy uncertainty. Uncertainty is high. Political trends are changing the environment for global policymakers across the globe and, in some instances, are changing their goals and reaction functions. Uncertainty about policymaker goals and objectives makes it more difficult for market participants to accurately discount prospective outcomes, and in my view, has increased volatility in markets. The Global Economic Policy Uncertainty Index has reached all-time highs over the last year (Figure 1).
  3. Trade conflict. The escalation of trade conflict has been a direct headwind for global trade volumes, which have been steadily declining. Trade conflict has also impacted supply chains, increased uncertainty, and weighed on investment and capital expenditure plans. Companies’ natural reaction to trade uncertainty has been to hold off on longer-term investment plans.
  4. Monetary policy interest rates. The steady increase in US policy rates in 2018 was a headwind for markets that culminated with the sharp market adjustments in the fourth quarter of 2018. Since then, the US Federal Reserve (Fed) has migrated to a more dovish stance and cut rates this year, which has been supportive of markets in 2019, offsetting some of the market headwinds from slowing growth, in our view.
  5. Central bank balance sheets. Central banks as a group aggressively expanded their balance sheets to support the global economy from the Global Financial Crisis up to the end of 2017. Since the end of 2017, however, the “big four” central banks, the Fed, the European Central Bank (ECB), the Bank of Japan (BoJ), and the People’s Bank of China (PBoC), have allowed the aggregate of their balance sheets to shrink (Figure 2). This has been led by the Fed and the PBoC but has not been offset by the increases at the ECB and BoJ. This shrinking aggregate balance sheet has been a headwind for the market.