Global stocks fell on Wednesday as investors reacted to further signs of an economic slowdown.
The immediate catalyst for the decline was the release of weaker US jobs data. September private payrolls rose at the slowest pace in three months and August job growth was revised lower. This release, which came a day after the ISM manufacturing index fell to its lowest level since June 2009, adds to concerns that the contraction in US and global manufacturing could be starting to undermine the strength of employment markets and consumer spending. Earnings releases from top US automakers were also disappointing. Meanwhile, political uncertainties over the launch of impeachment proceedings against President Donald Trump have added to existing uncertainty over the US-China trade conflict.
The market's retreat underlines our view that investors had become overly relaxed about risks stemming from the US-China trade conflict and a slowing global economy. We have a modest underweight to equities, and a preference for US stocks over the Eurozone, since we see the Eurozone as more vulnerable to a global industrial slowdown and the European Central Bank has less room to support growth through rate cuts than the Federal Reserve.
What are we looking for next?
The slowdown in manufacturing may have further to run, especially if—as we expect in our base case—the announced US tariffs on Chinese imports are implemented.
To be sure, the contraction in manufacturing needn’t mean the whole US economy slips into recession. Manufacturing represents only around 10% of the US economy. In the much larger service sector, sentiment remains robust, with the ISM non-manufacturing index registering a firm reading of 56.4 in August. In addition, if the weaker manufacturing sentiment is repeated in the Federal Reserve’s Beige Book and industrial production data confirms the contraction, the Fed would be more likely to reduce rates further in 4Q, which could help support overall economic growth.
However, as the ISM data illustrates, risks are elevated. We will be watching this week’s US nonfarm payroll report for any signs of deterioration, noting that the employment component of the ISM index dropped to 46.3 in September, the lowest in more than three years. We will be alert in the coming weeks for further signs that the manufacturing slowdown is spreading to other parts of the US economy.
What does this mean for investors?
We still believe that the US can avoid a recession, based on the resilience of consumer spending. It also remains possible that a trade truce between the US and China could lead to a rebound in manufacturing activity. But our base case is for the continuation of heightened tensions between the US and China. Against this backdrop, we don’t think stocks can move much higher from here and we remain modestly underweight equities, particularly markets like the Eurozone that are more exposed to trade and growth risks. We also favor income-generating strategies, such as through our overweight to USD-denominated emerging market sovereign bonds, which should benefit from easier monetary policy.