These days the investing world seems splitbetween two types of market participants: the believers and the skeptics.
Firmly among the believers are investors in equity markets, which haverebounded sharply from their sell-off in late 2018, supported by a dovishpivot by the Federal Reserve, hopes of a trade-war truce between the U.S. andChina, and the U.S. government going back to work. Yet this rally, with theS&P 500 up almost 20% since the low on December 24, has occurred even ascompanies’ 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 havetended to benefit from falling yields increasing the present value of futurecash flows. Bond markets, however, have started to price a Fed rate cut withinthe next 12 months, suggesting many investors see a downturn or recession inthe foreseeable future. And a recession isn’t good news for equitymarkets: Historically, the U.S. stock market (S&P 500) has fallen anaverage of 27% (peak to trough) during recessions.1
Recent data releases bolster the cautious economic outlook: They indicate theglobal economy is slowing meaningfully, and many global growth forecasts havebeen revised downward as well. This is not surprising to us as we’veexpected a growing-but-slowing global economy for some time (see PIMCO’sDecember 2018 Cyclical Outlook, “Synching Lower,” and May 2018 Secular Outlook, “Rude Awakenings”).
As one looks forward, what are markets telling us? This is where marketparticipants differ. The recovery in stocks suggests some have already boughtinto better days ahead, while fixed income markets suggest others remainskeptical.
China, the decider?
We will be discussing the near-term outlook for the global economy at our nextCyclical Forum in March, in which PIMCO’s investment professionals fromaround the world will gather in Newport Beach to debate key factors likely tocontribute to, or detract from, growth. We will publish our comprehensiveoutlook on global markets and economies after the forum. For now I share a fewthoughts on China, which will be high on our list of factors to discuss forseveral reasons, including the somewhat limited scope for upside surprises inthe U.S. and Europe over the next six to 12 months.
Chinese authorities have embarked on an enormous program of both monetary andfiscal stimulus, which could lift market sentiment. For example, new creditcreation surged to a record high of 4.6 trillion yuan (CNY) in January (seeFigure 2), exceeding levels reached in 2015–2016 (albeit under thePeople’s Bank of China’s old measure) as policymakers look tostimulate the economy. Recent data out of China suggest that these measuresmay 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 aggregatecredit creation grew 11% yoy (credit and export data from Bloomberg). Unlikepast Chinese approaches, which were more focused on demand (“shovels inthe ground”), this stimulus is supply side driven, so it’s hard toknow what the ultimate multiplier effect might be as there are no precedents.
In sum, the efficacy of the Chinese stimulus could be instrumental in decidingwhose views prevail: the believers or the skeptics. And if the believers areright, emerging market equities – given their proximity to the stimulusand current valuations – could be well-positioned to benefit.
For more on our asset class views for 2019, read our Asset AllocationOutlook,Late Cycle vs. End Cycle Investing.
Geraldine Sundstrom is a managing director and portfolio manager focusing on asset allocation strategies and is a regular contributor to the PIMCO Blog.