Global Macro Environment
Global Conditions Improving But Uncertainty Remains
The US economy grew at 2.1% in the fourth quarter signaling that the overall economy continues to grow, albeit at a slower pace. Strong employment, the US consumer and the housing market continue to be the bright spots in an economy looking to navigate a soft landing. The US unemployment rate remains at the cycle low of 3.5% and consumer spending and confidence remain elevated among geopolitical risks and uncertainty. In addition, lower interest rates helped power the housing market in 2019 as December new home sales were up 23% year-over-year. Manufacturing, the weak spot in the US economy for most of 2019, received a boost to start the year as the Institute of Supply Management (ISM) Manufacturing Purchasing Managers Index (PMI) returned to expansion territory for the first time since July 2019 after registering 50.9 in January, a 3.1 percentage points increase from December.
Economic data in Europe has been improving and the unemployment rate fell to a cycle low of 7.4% in December. Real GDP in the Eurozone was up 0.1% in the fourth quarter. In Japan, consumer confidence rose for the fourth straight month, further evidence the country is slowly moving past the VAT hike from October.
It is important to point out these fundamental improvements have come despite the negative economic impacts of the coronavirus. Historically, instances of prior viral outbreaks can have a material, yet short-lived impact on the global economy.
Fed Staying Patient For Now
The Federal Reserve left its benchmark interest rate unchanged and reaffirmed its make-no-moves posture. Prior to year end, officials signaled they were comfortable holding rates steady while they gathered evidence of how three rate cuts last year had cushioned the economy against a global growth slowdown. The post meeting statement from January repeated nearly verbatim the policy outlook expressed in December.
Geopolitical Developments: The US and China Sign Trade Deal and the UK Finally Leaves the European Union
On January 15 the US and China signed a landmark deal to sharply increase sales of US goods and services to China and help companies operating in China by better protecting their intellectual property and opening further Chinese markets, especially in financial services. The two nations have agreed to semiannual talks to push for reform in both nations and resolve disputes, reviving a format from previous administrations that Trump trade officials had once derided. In a demonstration of good faith, two days before the signed deal, the US announced it would drop its designation of China as a currency manipulator.
On January 31, the United Kingdom formally exited the European Union. Now difficult negotiations begin about their future ties. Boris Johnson, the UK Prime Minister, has said he would accept a complete break with the EU if trade deals can’t be worked out.
The viral outbreak of the coronavirus in China weighed on stocks around the world toward the end of the month. In January, the S&P 500 was flat (-0.0%), while small cap stocks suffered worse as the Russell 2000 was down (-3.2%). Uncertainty around the impact of global supply chains may continue to weigh on American companies that are exposed to China. The technology sector in particular is highly exposed to supply chain disruptions in specific areas of China if labor were to come to a stop. Travel-related companies, such as airlines and hospitality stocks, have already suffered.
International economies tend to be more trade dependent and thus are more sensitive to economic conditions in China. As a result, the viral outbreak and supply chain uncertainty negatively impacted returns for the month. Developed international was down (-2.1%) while emerging markets finished (-4.7%). Once the viral outbreak becomes contained, the improved economic picture and cheap valuations relative to the US could provide a tailwind for international equities.
Investors turned cautious which increased demand for bonds and pushed rates even lower as the 10-year treasury yield fell to 1.5% at the end of January. The Bloomberg Barclays US Aggregate Index was up (+1.9%) while municipals via the Bloomberg Barclays Aa+ 1-10 Year Index was up (+1.1%) for the month. Monetary policymakers will be watching for a sustained inversion of the yield curve (3-month/10-year). Historically a prolonged inversion, i.e. three months, has spelled trouble for financial markets. We will continue to monitor this closely.
MLPs (-5.6%) and natural resources (-7.6%) had rough starts to the year. US crude prices fell into a bear market in the first weak of February due to concern of reduced Chinese consumption. Saudi Arabia mentioned they are considering cutting oil production by up to 1 million barrels a day in response to the anticipated reduced demand. The standout for the month was real estate (+0.8%) as falling yields drove investors seeking income into real estate investment trusts or REITS. Real estate focused mutual funds saw inflow of around $1B in the first three weeks of January.
This Financial Landscape represents the consensus of the Oxford Investment Fellows as of 2.6.20 and is subject to change at any time due to market or economic conditions or other factors. Statistical data is derived from third party sources believed to be reliable and has not been independently verified by Oxford. The information above is for educational and illustrative purposes only and does not constitute investment, tax or legal advice.