The Macro View by Lionomics, August 2019

Investment review and outlook

We work with Wilshire, one of the nation’s largest investment research consultants, to bring you investment advice and market insights. Each quarter in The Macro View, we summarize Wilshire’s viewpoint on the macroeconomic landscape and the asset classes that may make up the core components of your investment portfolio.

What’s macroeconomics, you ask? It’s the study of large-scale or general economic factors, such as interest rates and national productivity. Let’s dive in.

Global stocks hit new highs and contrasting signals

Global equities (stocks) reached new highs during the second quarter of 2019, albeit with a heightened degree of market volatility. This global equity rally was boosted by the dovish tone of central banks. (A dovish tone refers to less-restrictive policies whereby banks generally lower interest rates or support other accommodative policies to spur economic growth. It’s the opposite of a hawkish tone, whereby banks generally raise rates and policies become more restrictive.) As a result of the heightened volatility, global uncertainty, and the rise in global equity prices, there has been a significant decline in global government bond yields (i.e., an increase in the price of bonds). 

While these lower bond yields contributed to the attractiveness of equities on a global basis, the bond and equity markets were sending contrasting signals. The bond market was anticipating slower growth and inflation, and bond prices reflected that pessimism. On the other hand, the stock/equity market was anticipating future earnings growth, specifically in the US, and equity prices were reflecting that optimism. 

But how can these contrasting expectations both be right? It’s unlikely. In fact, there is a reasonable probability that both markets are wrong. The bond market may be too bearish for the market and the economy overall, and the equity market may be too optimistic. So far in August, there has been increased volatility, with equity markets pulling back from the highs they reached earlier in July.

Volatility remains on an upswing

While the US consumer sector appeared healthy, negative business sentiment continued to weigh on the corporate sector. This serves as an indication that the economy may not be that bad; however, the earnings outlook (companies reporting their profits or losses) may not be that good, either! Unfortunately, this increases the probability of higher volatility and uncertainty ahead for equities and fixed income. 

As we have moved into the third quarter, there has been greater volatility in the markets due to conversations around interest rates, the Fed, trade policies, and the global economy

Asset class perspectives — going global

Below we’ve summarized Wilshire’s Q3 2019 viewpoint on the core components of MoneyLion members’ investment portfolios. Based on their review for the third quarter, Wilshire remained “overweight” to foreign equities and emerging markets, which means they believe that it’s important for portfolios to include an allocation to these different regions as a balance to US equities.

Fixed income vs. equity

Given that both stocks and bonds currently exhibit relatively high valuations (a valuation is the estimated value of an asset, and higher valuations typically raise prices), Wilshire believes it’s important to maintain a balanced portfolio given heightened volatility and global economic uncertainty.

Global ex-US vs. US equities

Wilishire believes that there continues to be slowing economic growth in foreign economies compared to the US. However, foreign equities are attractive on a relative valuation basis and are priced with a high degree of pessimism (i.e., they might offer more of a bargain because they have lower valuations and lower prices; they may be “underestimated.”). 

While Wilshire recognizes that the strength of the US dollar may persist in the near-term, it believes the valuation case (the “bargain” abroad) warrants an overweight position (a higher allocation than normal as compared to the target allocation for the asset class). Who doesn’t love a good deal? 

Emerging markets vs. developed equities 

Wilshire believes that currencies and equities have largely priced in existing geopolitical risks, and that stimulus from China is likely to spur an improvement in the global economic growth picture as the year progresses. However, valuations are less compelling on a relative basis due to lower expectations of corporate earnings growth. 

As a result, Wilshire is being careful about the amount of risk it’s allocating to emerging markets but still believes they are important to include in portfolios.

Investor sentiment — businesses not in a good mood

Despite the significant recovery in global equities, investor sentiment is still being negatively affected by heightened geopolitical risks, political dysfunction in the US, and slowing global economic growth. This negative sentiment has occurred even while consumer spending on goods and services has been strong! 

CEO confidence in the US — which indicates how likely businesses are to spend and invest — fell from very high levels, and ISM manufacturing and non-manufacturing surveys confirmed this drop in business sentiment as well.

Outlook: What to watch in the months ahead

Although global growth has slowed, there are some signs of stabilization in the Gross Domestic Product (GDP) growth of major developed market economies (measure of how productive economies are). US growth continues to outpace major foreign developed economies, as GDP in Q1 and Q2 outperformed expectations due to strength in personal consumption expenditures. See, shopping helps the greater good. 

Unfortunately, the recent decline in US Gross Private Domestic Investment (the amount of money that domestic businesses invest in their home country) has weighed on GDP growth, which is likely related to the decline in business sentiment and may indicate a lack of willingness to spend due to uncertainty regarding the business cycle and trade. 

In summary, the U.S. consumer appears healthy, and the economy would likely benefit from an improvement in business sentiment, which requires economic and geopolitical clarity — an unlikely outcome in the near-term. Those CEOs are so hard to please!

As we’ve said before, typically the best course of action is to stay diversified and invested for the long term to take advantage of the highs and cushion against the lows.

Disclosures

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