When entering the site and if cookies are prevented from being saved, a message must be displayed
in a popup message box informing the user that their local browser settings are preventing
cookies from being saved and that cookies are required for the site to work. Exact text
to be provided for UAT. On OK click of the message, the user should be redirected to
the global landing page (currently ssga.com).
Charting the Market: Driving with the Check Engine Light On
Trade conflicts between the US and China are slowing economic growth worldwide.
Bond term premiums are at their most negative level since 1961.
Investors can still find positive gains in equities if they know where to look.
Manufacturing represents around 10% of overall gross domestic product (GDP) in the US. However, when the sector sends signals, they can indicate much larger issues for the broader economic landscape. Think of those manufacturing signals like a car’s check engine light—when all is well, you don’t notice it. But when it’s sending a signal, you had better pay attention.
The most recent US manufacturing data turned the light decidedly on. In this edition of Charting the Markets, we will examine the recent trends in manufacturing data and how its path and pace may affect interest rate levels, equity returns, and global earnings growth.
Manufacturing data and bond yields
Despite the Citi Economic Surprise Index turning positive for the first time since February, manufacturing has not played a part in that rebound.1 The ISM Manufacturing Purchasing Managers’ Index (PMI) Index fell to its lowest point since 2009, sinking deeper into a contractionary phase of below 50. September marks the sixth straight month of declines, and all of this is coinciding with a reduction in global manufacturing, where an index of similar data is also below 502, as the US-China trade war constrains economic momentum all over the world.
With manufacturing indicating a more glacial and sluggish path for growth, long-term interest rates have moved in tandem –a relationship that is historically common as shown below. Long-term rates, after all, will reflect the market’s forward expectation for growth and inflation as an investor will demand a higher yield to lock up their money for a longer period of time where those dynamics can change and impact the principal, rather than own shorter maturity bonds. This is called the term premium, and right now term premiums are vastly negative – the most negative they have ever been back to 1961.3
With this backdrop and relationship, the ceiling for bond rates is likely to remain constrained.
Source: Bloomberg Finance L.P., as of 09/30/2019.
Manufacturing data and market returns
Weak manufacturing data has tended not to bode well for equity market returns. But the data does not have to just be weak; it also has to be weakening. As shown in the chart below, breaking out PMI by its different levels and direction can provide insight into what may lie ahead given the current situation. With PMI less than 50 and declining, historically, the subsequent 1-year return on the S&P 500® Index has been just 1%.4 With the month of October already starting off with a 1% loss, following the release of the aforementioned weak PMI data, the trend of lower future returns in a waning manufacturing sentiment and economic growth may persist into 2020.
Source: Bloomberg Finance L.P., as of 09/30/2019. Calculations by SPDR Americas Research.
Manufacturing data and earnings expectations
Trade woes and the decline in manufacturing activity both at home and abroad will likely lead to an earnings recession through the end of Q3. The US, however, is not the only one harmed by the US-China trade impact, as the chart below shows emerging market nations have seen full-year 2019 earnings-per-share (EPS) estimates decline from 12% a year ago, to just below zero today. Additionally, guidance has been weak for all considered regions—all analyst 2019 EPS up-to-downgrade ratio are below 1, indicating more downgrades than upgrades—as of September 30.
Source: Bloomberg Finance L.P.,FactSet, as of September 30, 2019. EPS growth estimates are based on Consensus Analyst Estimates compiled by FactSet. You cannot directly invest in an index.
Engine checked, now what?
The implied probability of two more rate cuts by the Fed in 2019 is a coin flip right now, echoing the policy uncertainty given the current situation.5 Yet, manufacturing is unlikely to mean revert unless there is a meaningful trade resolution. And if there is not, central bankers around the world are likely to enact monetary policy to juice growth and turn the economy around.
Considering current low rates6 and the lag of such actions, however, more rate cuts will likely only result in even lower debt yields. We may even see a return to a “there is no alternative,” or TINA, market environment where investors are pushed further out on the risk curve to seek out a return in excess of the risk-free rate plus inflation. To some degree, we are already seeing this evidenced by the record ETF fund flows into high yield ETFs. Additionally, weakening corporate growth makes it unlikely to stop gap volatility due to growing concerns about the global slowdown that may or may not culminate in a full blown recession.
How to drive with the check engine light on
But remember, the average return is 1% on the S&P 500 Index in this type of manufacturing scenario, so positive returns can be had. In fact, in 55% of such scenarios, gains were positive. So, what to expect? Much like taking a long car ride when that check engine light is on, it’s going to be a bit of white-knuckle ride for the rest of 2019 and into 2020—specifically if this weakness spills into the political arena and becomes an issue in the next election.
For this type of ride, appropriately diversifying is essential. Investors should consider a mix of defensive but upside participating equities, balanced yield, and duration bond strategies that do not take outsized credit risk, and alternatives with low correlations to both traditional stocks and bonds to get through the ride.
2 JP Morgan Global Manufacturing PMI Index is 49.7 as of 09/30/2019 per Bloomberg Finance L.P.
3 Bloomberg Finance L.P. as of 09/30/2019 based on the Adrian Crump & Moench 10 Year Treasury Term Premium.
4 Through October 4, 2019 based on the price returns of the S&P 500 per Bloomberg Finance L.P.
5 Bloomberg Finance L.P. as of 09/30/2019 based on interest rate probabilities for Federal Reserve Fund Futures.
6 60% of the bonds in the Bloomberg Barclays Global Aggregate Index already yield less the S&P 500 Index. Bloomberg Finance L.P. as of 09/30/2019 calculations per SPDR Americas Research where the S&P 500 Index dividend yield is 1.97%.
Purchasing Managers’ Index (PMI) Index
An economic index that reflects the economic status of the manufacturing and service sectors.
Bonds generally present less short-term risk and volatility than stocks, but contain interest rate risk (as interest rates raise, bond prices usually fall); issuer default risk; issuer credit risk; liquidity risk; and inflation risk. These effects are usually pronounced for longer-term securities. Any fixed income security sold or redeemed prior to maturity may be subject to a substantial gain or loss.
Equity securities may fluctuate in value in response to the activities of individual companies and general market and economic conditions.
Investing in foreign domiciled securities may involve risk of capital loss from unfavorable fluctuation in currency values, withholding taxes, from differences in generally accepted accounting principles or from economic or political instability in other nations. Investments in emerging or developing markets may be more volatile and less liquid than investing in developed markets and may involve exposure to economic structures that are generally less diverse and mature and to political systems which have less stability than those of more developed countries.
Because of their narrow focus, sector investing tends to be more volatile than investments that diversify across many sector sand companies.
ETFs trade like stocks, are subject to investment risk, fluctuate in market value and may trade at prices above or below the ETFs net asset value. Brokerage commissions and ETF expenses will reduce returns.
Standard & Poor's®, S&P® and SPDR® are registered trademarks of Standard & Poor's Financial Services LLC (S&P); Dow Jones is a registered trademark of Dow Jones Trademark Holdings LLC (Dow Jones); and these trademarks have been licensed for use by S&P Dow Jones Indices LLC (SPDJI) and sublicensed for certain purposes by State Street Corporation. State Street Corporation's financial products are not sponsored, endorsed, sold or promoted by SPDJI, Dow Jones, S&P, their respective affiliates and third party licensors and none of such parties make any representation regarding the advisability of investing in such product(s) nor do they have any liability in relation thereto, including for any errors, omissions, or interruptions of any index.
Distributor: State Street Global Advisors Funds Distributors, LLC, member FINRA, SIPC, an indirect wholly owned subsidiary of State Street Corporation. References to State Street may include State Street Corporation and its affiliates. Certain State Street affiliates provide services and receive fees from the SPDR ETFs. ALPS Distributors, Inc., member FINRA, is the distributor for DIA, MDY and SPY, all unit investment trusts. ALPS Portfolio Solutions Distributor, Inc., member FINRA, is the distributor for Select Sector SPDRs. ALPS Distributors, Inc. and ALPS Portfolio Solutions Distributor, Inc. are not affiliated with State Street Global Advisors Funds Distributors, LLC.
THIS SITE IS INTENDED FOR QUALIFIED INVESTORS ONLY.
No Offer/Local Restrictions
Nothing contained in or on the Site should be construed as a solicitation of an offer to buy or offer, or recommendation, to acquire or dispose of any security, commodity, investment or to engage in any other transaction. SSGA Intermediary Business offers a number of products and services designed specifically for various categories of investors. Not all products will be available to all investors. The information provided on the Site is not intended for distribution to, or use by, any person or entity in any jurisdiction or country where such distribution or use would be contrary to law or regulation.
All persons and entities accessing the Site do so on their own initiative and are responsible for compliance with applicable local laws and regulations. The Site is not directed to any person in any jurisdiction where the publication or availability of the Site is prohibited, by reason of that person's nationality, residence or otherwise. Persons under these restrictions must not access the Site.
Information for Non-U.S. Investors:
The products and services described on this web site are intended to be made available only to persons in the United States or as otherwise qualified and permissible under local law. The information on this web site is only for such persons. Nothing on this web site shall be considered a solicitation to buy or an offer to sell a security to any person in any jurisdiction where such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction.
Before investing, consider the funds' investment objectives, risks, charges and expenses. To obtain a prospectus or summary prospectus which contains this and other information, call 1-866-787-2257, download a prospectus or summary prospectus now, or talk to your financial advisor. Read it carefully before investing.
Not FDIC Insured * No Bank Guarantee * May Lose Value