Synchronized Global Growth No Longer Exists

Recent Tariff-Related Industry Performance

The 3 charts below show three industries which are supposed to be the most affected by the tariffs. The steel industry is supposed to be helped, but it has been down over 10% in the recent weeks. Investors aren’t hopeful that the tariffs will stick without a retaliation. While the overall market rebounded on Monday because investors realized that the small tariffs won’t crash the economy, investors are also expecting little positive impact. The whole prospected of a trade war has turned into a ‘nothingburger.’ The media narrative has run its course as national attention was gained even though major action hasn’t taken place yet. A threat of greater action isn’t a big deal unless it is acted upon.

The aerospace industry hasn’t been hurt by the tariffs even though it is exposed to them. The aerospace and defense industry will be helped by the increase in defense spending in the latest budget which is a much bigger deal than the tariffs. The transportation industry, which is also expected to be hurt by the tariffs, has had flat performance. It is also expected to be modestly helped by the recent budget as $10 billion was appropriated for infrastructure spending. I wouldn’t be surprised if another infrastructure bill is debated this year which promises to spend even more money on infrastructure.

Not Your Average Correction

The narrative in the financial press has shifted from expecting a melt up where stocks never fall, to one where pundits are saying this year will be a return to normalcy where stocks correct sometimes. I actually agree with the narrative. My advantage is I made this point before the correction rather than after it. Because corrections are fairly normal, the current one is being compared to others. As you can see from the chart below, the recent re-test of the lows makes this one lag the average of the past 6. I don’t think it’s fair to expect this one to come close to following the recent average because the decline is coming from a point where retail investors were the most optimistic in history. The market needs to bring more psychological pain before the euphoria is wiped out. Plus, the recent economic data doesn’t justify higher prices.

The chart below is much broader than the one above as it shows the average bear market and average correction in global stocks going back to 1979. It also includes the bounce back on Monday. The title of the chart implies that we don’t know if this will be a bear market or a correction. Clearly, it’s tough to tell just based on the price action, but that’s not all we have to look at thankfully. The cyclical economic momentum and the excessive speculation in stocks have run their course, but the weakness this quarter isn’t enough justify a bear market.

Recent Weak Economic Data

As I’ve mentioned, the global economic data is undergoing a cyclical phase change from coordinated accelerating growth to a deceleration. The chart below shows the recent economic data changes from the developed economics. The biggest recent weakness has stemmed from Europe and Japan. These are the same areas which were behind the weakness in late 2014 which was a precursor to negative S&P 500 performance in 2015. This is while America has actually doing the best in early 2015. The weakness was especially synchronized in the beginning of 2016 when there were fears of a recession. Economic growth, particularly in America, needs to fall further before recession headlines are shown. This chart gives the best explanation of why the market is down; it has little to do with tariffs and everything to do with poor data. An alternative viewpoint is to say the weak economic data makes the market more vulnerable to headlines, causing it to fall.

Capex Plans Expected To Increase

As you can see from the chart below, the 3 month moving average for year over year planned capex growth is the highest since at least 2006. The equipment growth is about 10%. It’s lapping the relatively easy comparisons in 2016. It will be interesting if the planned increase in capex spending will boost the economy or if the weak economy will cause the capex growth to moderate. The economy isn’t that weak, but capex growth wouldn’t be the highest of this cycle if it wasn’t for the tax cuts and the decline in the growth of regulations. The answer to this question will determine the success of the tax cuts because clearly an increase in S&P 500 EPS wasn’t the end goal of the legislation.

Equity Risk Appetite Is Still High

The chart below captures the risk appetite in various asset classes. Equity risk appetite is still the highest despite the recent correction. It’s interesting how various analyses can provide different results. Previously, I showed a chart which had equity volatility higher than the other asset classes and now this chart shows risk the appetite is only high in equities. It’s all up to the construction of each metric. I wouldn’t make trades based on this information, but they still provide interesting viewpoints opposed to simply looking at the normal indexes.

Financial Conditions Tightening Doesn’t Spell Doom

The financial conditions tightened after the corrections in stocks. This shows how reliant this index is on the ‘risk on’ trade. We saw how the index was getting easier last year despite the 3 rate hikes, because the market did well. Ultimately, many of the indicators we review depend on the mood of investors. My point here is that you shouldn’t sell stocks just because financial conditions have worsened because that equates to selling stocks because they are down.

Conclusion

I showed a great chart which has the developed economies all reporting less great, or in some cases bad, economic data. Don’t be distracted by the headlines; focus on the weakness in Europe and Japan. Eventually, that weakness will be in the headlines. At that point, the weakness will be priced in. I’m interested in seeing how the European economic deceleration affects the recent monetary policy guidance to end QE and raise rates in 2019.

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