With the China trade deal still in doubt and the “Fed Put” in place, US markets have almost rallied back from the 7% correction that occurred after trade talks fell apart in early May. This data-dependent Fed has stepped in with rhetoric about two possible rate cuts for the balance of the year to counteract the negative GDP implications of an extended trade war. Coupled with the China Ying and the Fed Yang is a bond market that is telegraphing a significant slowdown in the global economy. PMI’s in Europe are flashing signs of weakness with Germany leading the charge, and Japan’s flat line GDP trend looks to be secular given their glaring demographic issues. Signals of a global slowdown have driven interest rates down across most economies. In fact, about a quarter of outstanding global credit sits in negative rate territory and even the US 10-year Treasury yield is falling towards 2%. It’s hard to believe less than a year ago most forecasters were calling for a continued rise in US rates in the neighborhood of 200 basis points.
Why most global stock markets are still up for the year in the face of these challenges can be explained by liquidity and TINA (There Is No Alternative). While growth is slowing, liquidity is increasing and that liquidity needs to find a home. Private equity is sitting on trillions, bond offerings and IPO’s are having a strong year, the Chinese PBOC is in heavy stimulus mode, Europe remains under a QE regime, and US corporations had a record buyback year in 2018 ($1.2 trillion).
If we get a China trade deal coupled with an accommodative Fed and this unprecedented global liquidity, markets will move higher. If we get a delayed deal that moves sideways, markets move in a parallel line as well. If the negotiations completely break down and nationalistic fervor pushes both sides to make critical short-sighted decisions, it could be the tipping point for a global recession. We still believe scenario one is most likely and we get a deal that moves markets higher. Both sides have too much to gain with a deal and too much to lose with a nasty no-deal. Both have levered their economies to maintain growth and neither can afford to push the global economy into a recession. The 2020 election is looming as well, which could force US accommodation, while China is feeling greater pain in the short term that puts their growth plans at risk.
In the US equity markets, we have been using a barbell strategy to ensure we participate in the growth scenario, while remaining somewhat hedged should markets break down. Our core dividend growth strategy is having a solid year with rates dropping significantly. That portfolio’s yield of 2.9% offers an attractive alternative to the 2.15% percent 10-year bond, and is benefitting from positive liquidity flows. Within the portfolio itself, we continue to favor technology (especially 5G-targeted plays) and consumer staples and discretionary. We have also expanded our investments in the cell tower and data center REIT space. Equity valuations are neutral, so we are being careful picking our entry points.
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