The coronavirus knocked our 2020 outlook off track. But maybe not for long.

We’re hopeful that the virus can be contained and that pent-up demand will support growth in the second half

It wasn’t long ago that the ink was drying on our 2020 outlook, entitled “Getting Back on Track.” In it, we touted the conclusion of the third major policy-driven growth scare (along with 2012’s European debt crisis and 2015’s Federal Reserve [Fed] rate hike) of the elongated business and credit cycle. Stable growth and supportive policy were to be the theme of 2020. The Fed had already overturned the 2018 rate hikes and had successfully eased financial conditions, while the Trump administration had inked a Phase 1 trade deal with China. China, for its part, was working to stimulate its economy. The January reading of the Institute of Supply Management Manufacturing Purchasing Managers Index, as good of a leading indicator of economic activity as any other, would have traditionally been viewed by us as a resounding affirmation that the growth scare had passed. “Risk on!” we would have rejoiced. 

The ISM Manufacturing PMI bounced back into expansion territory in January

Sources: Institute for Supply Management, Bloomberg

The coronavirus detoured the economic growth path

Alas, “the normal times” were not to be. The rise of the coronavirus and the ensuing quarantines and ongoing lost production will ultimately represent a severe growth drawdown at an inopportune time for the global economy. No sooner was the third major growth scare of this cycle abating than the fourth significant scare was now upon us. In my view, that blue line in the chart above will no doubt be back below 50 in no time.

I am not going to attempt to quantify the expected loss in economic activity. (Other than to note that my colleague Paul Jackson, Head of Global Asset Allocation Research, is hopeful for a short, sharp downward shock to the Chinese economy during the first quarter, with recovery during the second quarter and second half — a path that is dependent on how long daily cases and deaths continue to rise.)

Instead, I will address the growth scare from the perspective of a market strategist, using frameworks to A) assess whether the business cycle is ending and B) determine potential market leadership based on the direction of economic activity and the policy response.

What does the ‘end-of-cycle dashboard’ show us?

It would be rare, if not unprecedented, for an infectious disease outbreak to lead to a global economic recession. Then again, global growth was already in a precarious state, the result of the uncertainty stemming from the US-China trade war. Rather than simply speculate on the prospect of a technical recession, I instead deploy an end-of-cycle dashboard comprised of telltale market indicators. Among them:

  • The shape of the US Treasury yield curve: As I pen this commentary, the spread between the 10-year US Treasury rate and the 2-year US Treasury rate is 11 basis points.1 Call it modestly steep or stubbornly flat but importantly, it is not inverted. Each of the past half century’s recessions have been proceeded by a prolonged inversion of the yield curve.2 Yes, the federal funds rate is above that of the 10-year US Treasury rate, as of this writing, but the relatively benign inflation environment provides cover for the Federal Reserve to cut rates, if necessary.
  • The strength of the US dollar: The US dollar has been strengthening once again and may break out against a trade-weighted basket of currencies. Watch the dollar closely, as capital flight to US-dollar assets would weigh on international activity and provide a headwind to the earnings of US multinational corporations. If the dollar gets too strong and deflationary impulses emerge, the Federal Reserve would once again be forced to act to stabilize the currency. 
  • The spread of US corporate bonds to Treasuries: Corporate bond spreads have thus far been behaving, remaining very tight from a historical perspective. In fact, high yield bond spreads tightened in the first half of February.

Pulling it all together, financial conditions thus far remain exceedingly easy compared to the starts of each of the past three recessions, as illustrated in the chart below. The picture does not seem to be suggesting that a recession is in the offing.  

The Goldman Sachs Financial Conditions Index does not suggest that a recession is imminent

Sources: Goldman Sachs, Bloomberg, L.P.

Where do we expect to see market leadership?

To determine market leadership, we ask ourselves three primary questions:

  1. What direction is the global economy trending?
  2. How will policymakers react to existing conditions?
  3. What will the impact of economic growth and policy be on capital flows?

To answer Question 1: There is no doubt that global economic activity is decelerating, with many of the usual trappings — lower rates, stronger dollar, weaker industrial commodity prices, bonds and bond proxies performing well even as the broader market has thus far held up well (don’t be surprised however if economic volatility leads to some near-term market volatility). However, in my view, the time to get defensive may have passed or prove short-lived. The optimist in me is hopeful that the virus can be contained, the Chinese labor force will gradually get back to work, and pent-up demand will support growth in the latter half of the year.

Regarding Question 2: I would also expect US and Chinese policymakers to act quickly, if necessary, to support growth and reflate the global economy.

As for Question 3: I believe that stabilizing growth and supportive policy would help support stocks over bonds, growth assets over value-oriented assets, and credit over Treasuries. This was my view at the start of the year and has been for most of this cycle.  

These three questions, and our thought process around them, are detailed in this infographic.

 And so, while I already used this title back in December, maybe I’ll recycle it for our midyear outlook — “Getting Back on Track.”

1 Source: Bloomberg, L.P., as of Feb. 24, 2020

2 Bloomberg L.P., as of Feb. 19, 2020. Recessions are defined by the National Bureau of Economic Research (NBER).

Important information

Blog header image: D3sign / Getty

All investing involves risk, including the risk of loss.

The ISM Manufacturing PMI, which is based on Institute of Supply Management surveys of manufacturing firms in the US, monitors employment, production, inventories, new orders and supplier deliveries.

The Goldman Sachs Financial Conditions Index is a weighted average of riskless interest rates, the exchange rate, equity valuations, and credit spreads, with weights that correspond to the direct impact of each variable on gross domestic product. An investment cannot be made into an index.

The opinions referenced above are those of the author as of Feb. 24, 2020. These comments should not be construed as recommendations, but as an illustration of broader themes. Forward-looking statements are not guarantees of future results. They involve risks, uncertainties and assumptions; there can be no assurance that actual results will not differ materially from expectations.

Brian Levitt is the Global Market Strategist, focusing on North America, for Invesco. He is responsible for the development and communication of the firm’s investment outlooks and insights.

Mr. Levitt has two decades of investment experience in the asset management industry. In April 2000, he joined OppenheimerFunds, starting in fixed income product management and then transitioning into the macro and investment strategy group in 2005. Mr. Levitt co-hosted the OppenheimerFunds World Financial Podcast, which explored global long-term investing trends. He joined Invesco when the firm combined with Oppenheimer Funds in 2019.

Mr. Levitt earned a BA degree in economics from the University of Michigan and an MBA with honors in finance and international business from Fordham University. He is frequently quoted in the press, including Barron’s, Financial Times and The Wall Street Journal. He appears regularly on CNBC, Bloomberg and PBS’s Nightly Business Report.

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