Russell Investments: Global Market Outlook Q3 – 19 China Syndrome

By Russell Investments

Synopsis

China stimulus, global central bank easing and a China-U.S. trade-war ceasefire could set the scene for a rebound in the global economy later in the year. However, the inversion of the U.S. Treasury yield curve and the downtrend in business confidence indicators keep us cautious at mid-year.

U.S. President Donald Trump’s tariff increase on Chinese imports in May triggered the end of this year’s equity market recovery. While the stock market has since rebounded, the lasting impact can be seen in falling long-term government bond yields, the inverted U.S. yield curve, the slowdown in global trade and weak global manufacturing surveys. As a result, it now looks increasingly likely that the U.S. Federal Reserve (the Fed) will cut interest rates in both July and September. A combination of Fed easing, China stimulus and trade compromise could make the recent yield-curve inversion a false signal. We will take the inversion much more seriously if it persists for a couple more months. At mid-year, it’s a worrying indicator that biases us toward caution.

In Europe, the region’s long-anticipated growth rebound remains just that—anticipated. Growth indicators are lack luster. And persistent low inflation has the European Central Bank pushing rate hikes further into the future. Bond market expectations for inflation in five years’ time have fallen to a record low of 1.2% as of mid-June. We’re not bearish on Europe, but the one-off factors that depressed growth are taking longer to turn around than anticipated. Overall, we see no signs that eurozone equities are either overbought or oversold, while core government bonds look long-term expensive.

The ongoing Brexit uncertainty continues to weigh on the British economy. We think British sterling will remain volatile in the short-term, but a rebound in the currency looks likely if the UK’s new prime minister can secure a deal with Europe, or if a second referendum is called.

The escalation of the China-U.S. trade war has put pressure on growth in the Asia-Pacific region, which suggests there will be further Chinese government stimulus measures that should benefit the region. Although the outlook for Australia remains lackluster, there have been a number of positive developments that should help the housing market stabilize, including a rate cut by the Reserve Bank of Australia. While we believe the Australian equity market is fully valued, we see slightly attractive valuations in Japan and Emerging Asia.

We believe the Canadian economy is gradually recovering, but we remain neutral on our outlook for domestic equities. We don’t see valuations as compelling yet, and our contrarian sentiment indicators remain far from oversold.