What a difference a year makes
Bottom Line During the late summer and early fall months of 2018, confidence metrics hit multi-decade cycle highs. The ISM manufacturing index was at a 14-year high, Back-to-School (BTS) retail sales hit a 7-year high and the labor market was strong. Stocks, however, started to roll over in early October from record levels, as investors were concerned that tight monetary policy from the Federal Reserve and the uncertainty of the developing trade and tariff war with China, among other issues, could push the U.S. economy into recession.
Today, confidence metrics have fallen sharply. At a 10-year low, the ISM manufacturing index is in contraction territory and the labor market has softened. September’s nominal retail sales were surprisingly negative month-over-month for the first time since February 2019, even though the collective BTS season was solid with a 4% year-over-year (y/y) gain. But after a 7% correction over the past three months, in which investors have adequately priced in these speed bumps, stocks are starting to resume their grind higher.
Importantly, the news for investors is starting to brighten. We continue to see no risk of a recession before the first half of 2021 at the earliest. The ongoing trade war with China appears to be thawing. A key meeting will take place on Nov. 17 at the Asia Pacific Economic Cooperation (APEC) summit in Chile between Presidents Trump and Xi, with the possibility that they might sign their trade truce into implementation.
Moreover, inflation has firmed, with the latest core PCE and CPI readings at 1.8% and 2.4%, respectively. The Fed has cut interest rates by a quarter point at both of its policy-setting meetings in July and September, and we believe another cut is in the pipeline for its Oct. 30 meeting. All of this is helping to flatten the yield curve, which inverted in summer and was giving investors a false recession signal. Overseas, fears of a dreaded no-deal Brexit are fading.
FactSet forecasts that corporate earnings in the third quarter will decline 3-4% y/y. But as we saw in the first half of 2019, companies engineered a positive, if modest, earnings increase by setting the bar low. We expect a similar positive surprise in the third quarter. In our view, the combination of better trade news, an accommodative Fed, benign inflation, low interest rates, a better-than-expected Brexit outcome and rising corporate profits should serve as a productive catalyst to drive stocks higher over the balance of this year and into 2020.
With benchmark 10-year Treasury yields at 1.75% and the S&P 500’s price/earnings ratio on $180 in estimated earnings for 2020 trading at only 16.7 times, stocks are still attractively valued. We continue to believe that stocks will rally up to our year-end target of 3,100, our mid-2020 target of 3,300 and our full-year 2020 target of 3,500.
Tweaking our GDP growth forecasts The fixed-income and equity investment professionals who comprise Federated’s macroeconomic policy committee met on Wednesday to discuss the changing economic picture over the past year:
- Second-quarter GDP was unrevised at a final reading of 2.0% growth and the Commerce Department will flash third-quarter 2019 GDP on Oct. 30.
- With the ongoing Chinese trade war, the surprising miss for September retail sales and the impact on manufacturing from the month-long General Motors strike, we are reducing our GDP growth estimate from 2.2% to 2%, while the Blue Chip consensus is cutting its estimate from 2% to 1.8% (within a range of 1.4% to 2.2%). The Atlanta Fed’s GDP Now estimate is at 1.8%, up from 1.7% last week.
- We are expecting a solid 4% gain for Christmas spending this year compared with 2018, but we still don’t know the timing or terms of the trade truce with China. So we are trimming our fourth quarter of 2019 GDP growth estimate from 2.4% to 2.3%, while the Blue Chip consensus remains unchanged at 1.8% (within a range of 1.3% to 2.3%).
- Our trims prompted us to reduce our full-year 2019 forecast from 2.4% to 2.3%, while the Blue Chip consensus remains unchanged at 2.3% (within a tight range of 2.2% to 2.4%).
- We are keeping our first-quarter of 2020 estimate unchanged at 2.4%, while the Blue Chip consensus remains unchanged at 1.7% (within a range of 0.9% to 2.3%).
- We are expecting stronger export volume to China, so we are raising our second-quarter of 2020 estimate from 2.5% to 2.6%, while the Blue Chip is keeping its estimate steady at 1.7% (within a range of 0.5% to 2.5%).
- Our third-quarter of 2020 estimate is unchanged at 2.5%, compared with the Blue Chip’s consensus also unchanged estimate at 1.6% (within a range of 0.4% to 2.2%).
- We also are keeping our fourth-quarter of 2020 GDP estimate unchanged at 2.5%, while the Blue Chip is lowering its from 1.7% to 1.6% (within a range of 0.8% to 2.2%).
- We are still expecting some progress on a Chinese trade deal before year-end 2019, with increased export volume to China during 2020, so we are keeping our full-year 2020 growth estimate unchanged at 2.4%, while the Blue Chip consensus is lowering its from 1.8% to 1.7% (within a range of 1.2% to 2.2%).