The Partnervest Monthly Global Outlook
By David Young, chief investment of officer of Partnervest Advisory Services, the portfolio manager of the AdvisorShares STAR Global Buy-Write ETF (Ticker: VEGA)
Despite the collapse of emerging markets and political jitters in Europe, the global economy continued to expand thanks to an increasingly strong US economy. Stock markets, though still skittish, finished the month in positive territory, sectoral surveys moved in encouraging ways, OPEC agreed to maneuver crude prices lower, and the Federal Reserve Bank appeared ready to pre-empt inflationary pressures. Despite continued signs of slowdown in Europe, Germany appeared ready for a recovery in the second half of the year.
The Fed announced it “would likely soon be appropriate” for an interest rate hike in June, the closest the Fed gets to committing itself to adjusting borrowing costs. It indicated that inflation is likely to surpass its benchmark 2% target and yields will rise gradually.
In his latest note, Bank of America Merrill Lynch CIO Michael Hartnett continued to warn of a “very late cycle” amid a “tightening Fed,” and he showcased as evidence current asset returns, particularly outperforming commodities sectors. Harnett noted that 2018 returns “scream Fed tightening and late-cycle,” citing commodities (12%), the US dollar (2%), stocks (2%), cash (1%) and, bonds (-2%).
DoubleLine CEO Jeff Gundlach, who called the commodity boom six months ago, laid out in his webcast his own case for late-cycle, long-commodities investment. He warned “rising rates and deficits are a pretty dangerous cocktail” and cautioned that Treasury yields may rise potentially in response to a shrinking Fed balance sheet. He also reiterated his forecast of recession in 2019.
Goldman Sachs was also bullish on late-cycle asset classes, telling investors that “It’s safe to invest in commodities again,” Bloomberg reported. Despite a decade of lackluster returns and simmering trade tensions, Goldman declared the “strategic case” for buying commodities from crude to copper “has never been stronger.”
In May, Goldman also touted the strengthening US dollar as a tonic for small-cap stocks which, registered only three underperforming weeks since the dollar began its ramp-up in February. The best risk-adjusted performing major asset in 2018 was crude oil and the weakest was investment grade bonds, according to Goldman.
US companies announced new stock buyback programs totaling about $183 billion in April-May earnings season, according to Trim Tabs Investment Research, following $191 billion in programs announced in the January-February earnings season. The buyback boom, which Trim Tabs said confirmed suspicions that windfalls from tax cuts will be plowed into balance sheets and not capital investment.
Topdown Charts illustrated how the Fed’s Quantitative Tightening, which has already reduced $70 billion worth of the bank’s securities, may have disposed of some $280 billion by the end of the year as it is scheduled to accelerate the pace of liquidation to $50 billion per month by October. It suggested that “if quantitative easing was a tailwind for stocks on the way up it stands to reason that it will be a headwind on the way down.”
Reuters reported that OPEC may decide to increase crude oil production as soon as June due to worries over Iranian and Venezuelan supply as well as US-raised concerns that the oil rally was going too far. It added that OPEC and non-OPEC producers, led by Russia, have agreed for the moment to curb output by 1.8 million barrels a day until the end of 2018 to reduce high global oil stocks.
Job growth accelerated in May and the unemployment rate dropped to an 18-year low of 3.8%, making the prospect of higher interest rates increasingly likely.
Economic growth slowed slightly in the first quarter amid downward revisions to inventory investment and consumer spending, but income tax cuts are likely to boost activity this year.
Meanwhile, the Atlanta Fed trimmed its Second-Quarter GDP estimate from 4.1% to 4.0% due to a decline in estimated real residential investment growth. Wages in May recovered after a dismal performance in April, as the Richmond Fed Survey rose to 16 from -3, well above the 10 estimate and at the top end of the forecast range. While the rebound in optimism was below March levels, robust employee growth and surging wages made this the highest print in 21 years.
The Commerce Department reported a decline in Core Durable Goods Orders for April due in part to slowdown in aircraft purchases. Orders slipped more than expected at -1.7% MoM, below expectations of -1.3% and down from last month’s 2.7% rise. In addition to declining aircraft orders, the data revealed a drop in ex-defense durables which plunged -1.9% in April, nearly double the -1.0% expected, and a big drop from last month’s 4.3% increase.
A Reuter’s poll found that nearly one-in-three economists expect a U.S. recession in the next two years, citing such end-of-cycle developments as rising interest rates and commodity prices as well as secular concerns like rising trade barriers. “The risk of a recession really picks up after a year, or sometime in 2020, said Joseph Song, senior U.S. economist at BAML, “because that is when you start to see the fiscal stimulus start to fade.”
Speaking of stimuli, Oxford Economics ran crude-oil prices against both tax cuts and the budget bill passed this year and concluded that if crude-oil prices averaged $70 a barrel this year, half of the fiscal boost would be eroded.
Surveys were largely positive in May. The Manufacturing PMI survey surged to an expected 56.5, its highest level since Sept 2014. Output rose at its fastest pace since January 2017 as inflationary pressures intensified dramatically. ISM Manufacturing meanwhile dropped to 57.3, its lowest since July 2017. ISM Services data was mixed as orders were up but business activity and employment fell.
The University of Michigan sentiment survey for May showed a decline in current conditions, and a small increase in hope, but the final data showed both slipping markedly on an intra-month basis with the headline sentiment index at its lowest since January. Headline Sentiment slipped from 98.8 in April to 98.0 while current conditions fell to 111.8 from 114.9 and Expectations slipped from 89.1 from 88.4.
Bloomberg reported that consumer sentiment in the U.S. settled back to a four-month low in May amid less-favorable buying conditions for homes and big-ticket items. Notably, consumers anticipated income gains of 1.6 percent, down from 2.2 percent in April and 2 percent last year.
Harvard professor Carmen Reinhart shared with Bloomberg a grim appraisal of emerging markets, describing them as “having a lot more cracks now than they did five years ago and certainly at the time of the global financial crisis.” Reinhart took note of higher debt levels in emerging markets, as well as the increased exposure of that debt to foreign currency.
Reuters reported that US fund investors pulled the most cash in more than 18 months from stocks in those regions, according to Lipper. Nearly $1.2 billion bolted emerging market mutual funds and exchange-traded funds during the seven days ending May 30, according to the research service, the largest withdrawal since November 2016.
Economist Klaus Wohlrabe of the Ifo institute, one of Germany’s largest think tanks, declared that Europe’s largest economy “is holding its ground” despite an uncertain economic outlook. Ifo’s business climate index held at 102.2 in May, halting a five-month slowdown in Europe’s largest economy that started at the beginning of the year.
Meanwhile, the ECB Governing Council cautioned in the minutes of its April meeting that “the uncertainty around the outlook had increased since a more pronounced weakening of demand, notably related to external factors, could therefore not be ruled out.” In particular, it warned of such destabilizing events as a rise of protectionism.
In a similar development, Japan’s economy shrank by 0.6% on an annualized basis in the first quarter of the year, the end to eight straight quarters of GDP expansion, the nation’s longest growth streak in 28 years. Economists said the contraction will be temporary despite fears of trade friction with the US that could hurt export demand.
Even China may be flirting with a slowdown. Reuters reported that, despite consensus forecasts that the Chinese economy has been steady at 6.8-6.9% over the past year, analysts are sticking to estimates that it will gradually lose steam in coming months. Economists polled by Reuters expect a slowdown to around 6.5% this year and a handful of China watchers believe activity has already slowed well below official estimates.
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