Are We There Yet?

Key Points
  • Recent hiccups in U.S.-China trade talks and uncertainty around a “phase one” deal have reaffirmed that trade headlines continue to drive larger market swings.

  • Key U.S. economic data has been on the weaker side—holding the United States back from participating in an emerging global manufacturing recovery.

  • Negative interest rates around the world have created favorable financing conditions for manufacturing firms, harboring the global labor market from a downturn.

“The noblest pleasure is the joy of understanding.”
—Leonardo Da Vinci

Reality check

After a near-two-month lull on the trade news front, a surge in investor optimism, and reduced fears of a near-term recession, U.S. stocks remain fairly elevated but are off their all-time highs. Trade tensions between the United States and China briefly resurfaced after recent reports that a “phase one” deal may not happen by year-end, and no decision has been made to delay or roll back the December 15 tariffs. Accompanied by November’s weaker U.S. manufacturing and construction data, renewed trade uncertainty helped stoke fears that an uptick in domestic economic growth may not be as imminent as many had hoped. The initial rally to new highs for U.S. stocks was led by cyclical sectors, but some defensive sectors have since taken back the lead; suggesting that investors are not fully convinced of a near-term economic rebound.

Aside from the ongoing tug-of-war between cyclical and defensive sector leadership, small-cap stocks have failed to meaningfully break out and overtake their large-cap peers; and international indexes have not confirmed the new highs seen in the United States. Nonetheless, U.S. stocks have mostly ignored mediocre economic data and weak earnings growth; focusing instead on trade optimism. In turn, some measures of valuation have climbed quite markedly; and we may be approaching a point when earnings growth will have to do more of the market’s heavy lifting. [Read how valuation is as much a sentiment indicator as it is a fundamental indicator in Any Weather: Valuations Say Stocks are Cheap and Expensive].

Growing global

The aforementioned weakness in U.S. manufacturing reinforces the narrative of the still-firm dividing line between the manufacturing and services sectors. November’s Institute for Supply Management (ISM) Manufacturing Index missed consensus estimates and fell to 48.1; while the Non-Manufacturing Index ticked down to 53.9. Though the latter also missed estimates, the overall level remains above 50, which separates expansion from contraction and suggests that services remains relatively strong. Given the still-healthy consumer and gradual fading of trade tensions, investors had hoped for a pickup in activity synonymous with the recent improvement in global manufacturing data. As you can see in the chart below, the global Purchasing Managers’ Index (PMI) has continued to rebound on a year-over-year basis; thus diverging from the U.S. manufacturing and services measures. By no means does this suggest the entire globe has shifted into growth mode, but data of late has trended favorably.