Turning Up the Heat

Global capital market volatility rose in May, propelled by amplification in the U.S.-China trade dispute, which has led to concerns about global growth. The month also proved a powerful reminder of the importance of maintaining robust sources of true portfolio diversification as positive performance from Risk Control assets helped offset sharp declines in global equities.1

Here are five key takeaways for the month:


Market Pulse

A Higher Dose of Uncertainty

After a meaningful snapback after 4Q 2018 declines, global risk assets lost ground in May, while maintaining solid year-to-date gains. Investor risk appetite waned as President Trump pumped up the volume on the U.S.-China trade dispute, with the Trump administration raising the existing 10% tariff to a full 25% on $200B of Chinese imports and threatening to impose a 25% tariff on all Chinese imports. China has retaliated with U.S. import tariffs, and both sides appear resolute heading into the G-20 talks in late June. Adding to this complexity, the U.S. decision to blacklist Chinese smart phone manufacturer Huawei effectively banned U.S. firms from transacting with the company and sent a strong signal to China that 5G dominance is not a forgone conclusion.

While trade tensions were focused on U.S.-China dynamics, President Trump also surprised the markets with an announcement of tariffs on Mexican imports in response to border security concerns. Increased economic weaponization and the pace of these announcements is naturally unsettling and adds uncertainty, for which investors expect to be compensated; hence, lower risk asset prices.

A Difficult Month for Global Risk Asset Markets

Source: Morningstar Direct as of May 31, 2019. All returns shown as total return on a U.S. dollar basis.

May Tit-for-Tat Trade Timeline


Macro View

A Self-Fulfilling Slowdown

While we have spent more than a fair amount of time considering the impact of the U.S.-China trade conflict, we observe that momentum in the U.S. and global economies has already slowed. Whether it is companies preparing for a prolonged trade war or responding to the slowdown in global demand, global activity is clearly decelerating.

Some of the slowdown feels very much like a self-fulfilling prophesy, whereby trade tension spurs uncertainty, uncertainty encourages businesses to become more cautious with respect to capital spending and hiring, and growth slows. This slowdown can manifest in a more cautious consumer, regardless of the low unemployment rates around the world.

Our view is that the global economy will avoid a recession; however, the risks of a more protracted slowdown have increased. The U.S. remains in the best relative position, with Europe and Asia more vulnerable to the downside of trade conflict.


Policy Front

Central Banks, Do We Have Your Attention Yet?

The combination of negative trade headlines and softening data has been reflected in a significant fall in global interest rates. We have seen yields drop in the U.S., Europe, Japan and Australia in a “flight to quality” trade, but also as a manifestation of a consensus view that global monetary policy needs to remain easy, at the least, or even become more accommodative.

In the U.S., we have seen a massive move down in 10-year treasury yields and growing pressure on the Fed to lower interest rates. Short rates are reflecting the market expectation of two rate cuts, and the 3- and 6-month 10-year yield curves are inverted, with shorter-term rates above the 10-year yield.

Historically, inverted yield curves have been a leading indicator of significant economic weakness and have provided a clear signal to the Fed that easing policy is required. In our view, the Fed will ultimately listen to the market, and we expect at least one rate cut this year.

The U.S. Treasury Curve is Sending a Clear Signal

U.S. Treasury Yield Curve

Source: Bloomberg as of May 31, 2019.


Fundamentals Focus

Positive 1Q Earnings Growth, but with a Lower Bar to Chin

Entering 1Q, many worried we may experience the beginnings of an earnings recession in the U.S., with negative earnings growth in the 1Q becoming a consensus view. Analysts had lowered estimates accordingly. And with 1Q results solidly in the rearview mirror, it appears that S&P 500 companies successfully chinned the lowered bar, beating estimates and even avoiding a negative quarter. Although revenue growth was subdued, the upside surprise was a function of better bottom-line growth and, in particular, better net margins as tax rates remained lower than expected.

We believe U.S. earnings growth will remain relatively slow in 2019 – in the mid-single digit range. But we also believe that the combination of accommodative monetary policy and low-but-positive earnings will support U.S. equity prices.


Segment Spotlight

Is Low Inflation Too Much of a Good Thing?

Investors often ask, “What’s so bad about low inflation?” Logically, nobody likes to pay higher prices for goods and services, so this seems like a good question. However, the reason the Fed and economists grow concerned about inflation running too low is that “low inflation expectations” can morph into “no inflation expectations,” and this has negative feedback loops into the economy. When consumers expect no inflation, consumption is deferred, which leads to slower profit growth and, in turn, can lead to suppressed jobs creation and even layoffs. It certainly does not lead to wage increases, which are critical – and when absent, can impair standards of living. It is interesting to note that actual inflation does not have to be low; rather, it is inflation expectations that matter and influence behavior. This is why the Fed wants to see inflation at a comfortable, but low, 2% level in addition to well-anchored inflation expectations.

We have been confident that future inflation would be low – lower than the Fed’s preferred target, due to technological innovation and demographics. These observations impact not only U.S. inflation, but also the global outlook. We expect the Fed and other central banks will come around to recognizing the incompatibility of current monetary policy with the low-growth/low-inflation world and, in turn, anticipate easy, and even easier, global monetary policy.

  1. At Northern Trust, we categorize assets into two “super” asset classes – what we call the Risk Control and Risk asset portfolios – as the foundation for our asset allocation methodology. Risk Control assets include cash, investment-grade taxable and tax-exempt bonds, and inflation-protected bonds. Risk assets include high-yield bonds, developed global equity, emerging markets equity, natural resources, real estate and infrastructure, private equity and hedge funds.


This information is not intended to be and should not be treated as legal, investment, accounting or tax advice and is for informational purposes only. Readers, including professionals, should under no circumstances rely upon this information as a substitute for their own research or for obtaining specific legal, accounting or tax advice from their own counsel. All information discussed herein is current only as of the date appearing in this material and is subject to change at any time without notice.

The information contained herein, including any information regarding specific investment products or strategies, is provided for informational and/or illustrative purposes only, and is not intended to be and should not be construed as an offer, solicitation or recommendation with respect to any investment transaction, product or strategy. Past performance is no guarantee of future results. All material has been obtained from sources believed to be reliable, but its accuracy, completeness and interpretation cannot be guaranteed.