Though economic growth continues to slow around the world, we see limited signs of an impending recession.
Global economic data may continue to indicate weakness near term. However, we expect the manufacturing-driven slowdown to reverse course later in the fourth quarter without a recession.
The Federal Reserve (Fed) will likely cut its key policy rate in October and December of 2019. Elsewhere, the European Central Bank and Bank of Japan have indicated signs of continued easing until growth and inflation approach mandated targets.
Global growth consensus forecasts have stabilized across developed and emerging market economies. Absolute levels of real GDP still look decent for this year and next.
We still expect labor market strength and rising wages. However, these conditions may not result in substantially higher consumer price inflation as they have in past expansions.
We fear manufacturing sector weakness could bleed through to service-oriented sectors, leading to increased job loss. For now, we see limited indications of such an outcome.
We see excess return potential as long as financial conditions can hold steady.
Global growth remains moderate and 2019 corporate earnings are still likely to rise in the low-single-digit range.
Changes in the economic outlook will likely determine the trading range for credit spreads. Deterioration could push spreads wider, while improvement could move spreads tighter. The global thirst for yield is supporting a strong bid for credit, which should keep spreads relatively stable.
We believe consensus estimates for 2020 corporate earnings may be too high, especially if the manufacturing recovery develops slower than we anticipate, or does not materialize at all.
The credit sector’s yield and excess return potential hinge on corporate profit and global economic growth. As long as these metrics continue to expand, credit investors should be able to harvest some yield and modest excess returns.
US high-grade corporate credit quality continues to trend positive across most industries. We think downgrade concerns about BBB-rated credits in the next economic downturn are valid, but perhaps a bit overblown.
Central banks around the globe are cutting interest rates in response to weaker economic growth. Dollar strength seems likely to persist in this environment.
After facing pressure all year, global interest rates spiked in September as global PMI data stabilized. We see a pickup in economic activity in the months ahead, but not quite yet. When it does materialize, more positive economic data should help the global economy out of this soft patch of growth. That said, we do not anticipate a boom or inflationary impulse.
Inflation pressure in the US remains nonthreatening and the global growth outlook still appears soft, supporting our view that the Fed will cut interest rates twice more by year-end.
Market-based expectations for the federal funds rate suggest only one more twenty-five basis-point cut in 2019 and two additional cuts in 2020. If economic data picks up like we expect, the economy might not need that much support from the Fed in 2020.
Emerging market debt may prove to be an attractive opportunity for investors looking for higher yield potential. However, the US dollar is likely to stay strong.
Forward valuations look a bit elevated at the index level, underscoring the importance of security selection.
Price-to-earnings multiples expanded from very low levels this year. We see little opportunity for further expansion, even with a more accommodating Fed and long-term yields near multi-year lows across the globe.
The outlook for corporate earnings and global growth remain critical factors helping to drive equity market performance. Downside risks include uncontrolled trade escalation between the US and China and a slower-than-anticipated uptick in economic activity. Both could impact earnings and equity markets negatively.
US trade policy remains a source of uncertainty for corporate decision-makers and investors. Clarity on trade negotiations with China and some sort of deal, even if small, would introduce potential upside risk to global equity markets.
We have seen a weak trend in 2020 earnings estimates all year. The US has held up relatively better than global peers, which is one reason we prefer US equities over global equities.
We expect 2020 earnings growth in the mid-single-digit range worldwide, based on our fairly sanguine economic outlook. Japan and emerging Asia may continue to show relative weakness.
Tariffs and trade conflict between the US and China cast a cloud over an otherwise solid economic outlook. Outright recession risk appears low, but we need to see a cyclical pickup soon.
Consensus estimates for domestic growth could still head lower, but we believe the probability of a US recession is low. We expect US and global economic data to begin improving.
US-China trade negotiations remain a major downside risk to our growth outlook. Trade talks are scheduled for early October. Despite economic weakness in both the US and China, neither side appears ready to give in.
We are watching geopolitical conflicts with Iran and other nations. If geopolitical developments worsen, investors may demand compensation for the added risk, driving risk premiums higher. Credit spreads and equity markets would likely stumble.
Consensus earnings growth estimates for 2019 have been revised down into the low-single-digit range for the US, Europe and emerging markets. Japan could see outright declines in corporate profitability this year. We believe earnings growth needs to improve to support equity performance through 2020.
An uptick in high-frequency economic indicators could go a long way to support investor sentiment and risk assets. For now, investor sentiment still reflects end-of-cycle fears, which may be overstated. We believe the expansion should continue through 2020.
Disclosure
This commentary is provided for informational purposes only and should not be construed as investment advice. Any opinions or forecasts contained herein reflect the subjective judgments and assumptions of the authors only and do not necessarily reflect the views of Loomis, Sayles & Company, L.P. Investment recommendations may be inconsistent with these opinions. There is no assurance that developments will transpire as forecasted and actual results will be different. Data and analysis do not represent the actual or expected future performance of any investment product. Information, including that obtained from outside sources, is believed to be correct, but Loomis Sayles cannot guarantee its accuracy. This information is subject to change at any time without notice.
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