We see some glimmers of hope, however. While the latest rounds of negotiations over the U.S./China phase one trade deal have stalled, we think prospects remain for a limited agreement and new tariffs could likely be delayed. Even as tariffs have been in place and as economic data from the eurozone has been spotty, Chinese export levels have been picking up, which is a critically important indicator of broader global trade levels. It is too early to say whether this improvement is a harbinger of better things to come, but it is clearly an optimistic signal.
At present, equity prices reflect a better trade environment, and we hope those signals are correct. A reduction in tariff levels (or even an easing in trade tensions and more clarity around future policy) would be bullish for stocks. If corporate management teams had a better sense of where trade issues were heading, they would be more willing to invest in their businesses, which would be a positive for corporate earnings and profits.
Monetary Policy May Have Run Out Of Steam
Part of the reason we have a cautious outlook toward the economy and global financial markets is that monetary policy may have exhausted its ability to provide a tailwind for stocks. Global monetary policy remains extremely accommodative, but central banks, including the Federal Reserve, now appear in a holding pattern.
The drop in interest rates over the course of 2019 has been a positive for stock markets. But at this point, we have a hard time seeing additional cuts without also seeing notable economic weakness. And such weakness would be a negative for stocks and would probably outweigh any additional benefits arising from even lower rates.
In contrast, if economic growth does pick up (perhaps due to better news on the trade front), policymakers will come under increasing pressure to once again raise interest rates. We don’t see that happening in the near term given how cautious central bankers have been, but monetary policy is less clear now than it was earlier in the year.
This is particularly true given the current monetary policy backdrop. Conditions remain extremely accommodative and equity friendly, but the Federal Reserve seems unlikely to push interest rates any lower, unless it sees fresh evidence of economic weakness. And such evidence would be a bearish sign for stocks.
We Remain Mildly Constructive Toward Stocks
We are hopeful that a modest improvement in economic growth will take hold, and we see prospects for better trade conditions from here. A slow recovery in manufacturing and trade would probably cause interest rates to rise modestly, but not to the point that rising rates would damage equity markets. At the same time, corporate profits could grind slowly higher in 2020. All told, such an environment causes us to be mildly constructive toward stocks.
The risks, however, appear skewed to the downside. The problem is those risks are more about political issues and policy decisions rather than economic fundamentals. Politics and policy mistakes are much harder to handicap than issues such as economic weakness or credit fundamentals, making them particularly tough to plan for.