Recession a concern but not imminent, says AGF PM

Despite jitters over weak numbers and trade wars, investors have a solid backdrop and brighter outlook to hold on to

Recession a concern but not imminent, says AGF PM

Recession has undeniably been on investors’ radar over the course of 2019, and justifiably so; with the bull cycle going into its tenth year, it should be hard to believe that it can run much longer. And there certainly are signs of weakness, if one knows where to look.

“Purchasing manager diffusion indexes have been weak for a fairly significant period of time,” said Mike Archibald, Associate Portfolio Manager at AGF Investments Inc. “That’s mostly related to some of the events we’ve seen with respect to China and U.S. trade. Earnings estimates have come down quite a bit, so we’re probably going to have a fairly flat overall year for earnings growth. And there’s been a realization by the market that the economic data has been fairly poor this year.”

According to Archibald, the skittishness among investors is clear in their elevated cash levels and the dominance of defensive positioning in the markets this year. Sector returns for virtually every global index have been skewed toward areas with high dividend yields and low overall beta, and bond-like sectors have done very well as global yields declined around the world.

“Utilities, real estate, and consumer staples have done extremely well,” he said. “On the other hand, cyclical sectors, particularly resource cyclical areas, have been poor performers.”

That nervousness is also clear from an investment-fund perspective, with a lot of money flowing out of equity funds and into cash or bond funds. But while recession is certainly a concern at AGF, it’s not a near-term one.

“We’re not seeing a lot of red flags at the moment,” Archibald said. “Many of the other indicators we’re paying attention to are telling us that there’s still a decent backdrop out there. Equity markets and the global economy are still in a relatively good place: not growing significantly, but also not contracting.”

There’s also a developing agreement within the market that weakness in economic data is poised to bottom out, suggesting a high probability of better numbers in the coming year. That improvement, he said, ought to trickle down to benefit this year’s underperforming cyclical sectors.

“Eventually the deeper cyclical areas of the market like energy and materials should start to take over market leadership,” he said. “We've started to see some of that happening recently whereby industrials and discretionary and financials in particular have started to act very well.”

The aging bull market is also getting some support from policies being enacted by the U.S. Federal Reserve, including massive stimulus and interest-rate reductions, which Archibald expects to have a rousing effect on the markets between three and six months from now.

“All of these things should drive more risk-seeking behaviour and result in a better earnings outlook for the overall S&P 500 at the micro level,” he said. “We’re likely going to see bond yields go back up a little bit, which should ease some of the concerns around slowing global growth. .”

The Bank of Canada is also likely to follow suit in reducing interest rates. In its most recent policy announcement, the central bank said that the domestic economy is performing in line with expectation, but is starting to face some tougher challenges. That suggests a possible reduction in borrowing rates sometime in the next six months, which will provide more stimulus and set the stage for more consumer spending.

And while 2018 was notable for bouts of market volatility and the absence of a Santa Claus Rally in the fourth quarter, Archibald is expecting a more standard response in the closing months of 2019. Earnings came in better than expected in Q3 this year, with fewer companies performing below estimates. In the first 10 months of 2019, the S&P 500 has returned 15%; looking back at historical periods where the S&P 500 has returned 15% or better in the first 10 months of the calendar year, in 17 out of 18 of those occurrences, the index has been positive in the last 2 months of the year, with an average return of just under 5%.

“There’s still a chance of some volatility in the marketplace,” he said. “But with that historical trend, as well as the fact that there’s still a lot of cash on the sidelines waiting to be deployed, we’re not likely to see a repeat of last year.”


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