Market Commentary: As The Global Economy Slows, The Grab For Yield Will AccelerateJan. 28, 2019 1:23 PM ET
Rida Morwa's High Dividend OpportunitiesSummary- Market Commentary: Despite a weaker global economy, there is good news.
- Where will equities be heading in 2019?
- Listen to what the Bond Markets are Saying.
- The hunt for High Yield is set to accelerate.
- More highlights for our strategy in 2019.
As per our analysis over the past several months that the global economy in 2019 will slow down, we are now starting to see clear signs of deceleration at a rate faster-than-expected. Alarming data recently caught the eye of investors and was reinforced by poor data releases from China, Japan and the Eurozone:
China growth rate is at its lowest rate since the year 1990, now only at 6.4%.
The eurozone economy began 2019 with activity growing to its lowest pace in more than five years, and expected to grow at a rate of 1.8% Year-On-Year, following a decline in Q3 and Q4 2018.
The IMF cut its estimate for global growth this year to 3.5%, from the 3.7% due to heightened trade tensions and rising interest rates.
It is irrefutable that global growth is in a synchronized slowdown with inflationary pressures continuing to be almost non-existent in most of all major economies.
The only major economy that is still growing at a healthy pace is the United States, but no economy is an island by itself. The global economy has peaked in the first quarter of 2018, but the US economy got an extra boost in 2018 from the tax reforms which has delayed signs of slowing down until this year. The US economy, according to the Federal Reserve will only grow by 2.3% compared to 3% in 2018. Projections point to an even slower growth in 2020 which is likely to be a growth below 2% based on our own analysis.
Where is the Good News?Despite a weaker economic outlook, there is some good news. Almost all the major central bankers are acknowledging the fact that the risks to the global economy are increasing, and are talking about a continuation or a restart of quantitative easing. It seems that the latest market correction (or mini bear market) that we saw in late 2018 was a wake-up call. While "bear markets" are usually the result of an economic recession, market crashes can increase the recession risks as asset prices melt down. This can also drag the global economy into a recession.
So what we are seeing now - contrary to what we were seeing in 2018 - are more dovish central bankers.
Let us look at some details:After the U.S. Federal Reserve embarked on its plans to normalize interest rates by hiking them several times during the past two years, the Fed is now showing willingness to listen to investors' worries about a flattened yield curve and weakening business and consumer sentiment. The Fed finally woke up and declared that rate hikes in 2019 will slow down to only two (from three rate hikes,) and left the door open to no hikes at all. More importantly, it now appears that the Fed will consider ending its bond portfolio runoff earlier than previously announced which is also a sign that the Fed does not want to derail the economy.
We also heard last week from two major global central banks - for both Japan and the Eurozone - that quantitative easing needs to continue because of a poor inflation outlook. There is no need or willingness to hike interest rates. The Eurozone continues to delay its plans to hike rates, and most likely this will continue for several years in my opinion.
As for the Bank of China, they are using every tool available to them in term of quantitative easing to stimulate their faltering economy.
This is ironic to see that the central bankers of these major economies were so upbeat about global growth last year, and being completely wrong.
This kind of synchronized recognition of risks by Central Banks, and coordinated efforts to stabilize the global economy, can have some wonderful results if the decisions are taken at the right time, meaning not being too late. Today is not too late, and in my opinion the deteriorating situation that would cause a global recession can be delayed several years.
In fact, if executed properly, these International Bankers have a good chance of shifting the economy back to growth next year, and thus pushing any recession risks until 2022 at least.
There remains one big hurdle to be overcome which is a trade deal between the United States and China. The recent trade war had a big negative impact on the global economy, and once this issue is resolved, then we can be more confident that recession risks will dissipate. I would like to reiterate my views on this point that both the U.S. and China presidents are aware that they have no choice but to resolve the situation, and so I believe we are likely to see a deal sooner rather than later.
The bottom line is that with all central bankers on board to rekindle growth, I am even more confident today that we will not see a global recession before the year 2022.
Why is inflation so stubbornly low?Inflation in the United States has remained stubbornly low despite stellar economic growth last year. In fact, inflation has been consistently lower than the Fed target rate, even in 2018.
We have touched on this subject before; the reason behind such a low inflation can be attributed largely to both an aging population and lower population growth rate. Economic growth comes mostly due to population growth as more and more people enter the workforce, start generating and spending money. For example, the Baby Boom generation contributed to a growing population with increased spending and consumption needs.
In today's aging global population and decreasing birth rates - in the US and more notably in other major economies - we do not have this luxury anymore. This means that the U.S. and other developed economies are more fragile today because demographics just do not support them. Economic growth and a minimum level of inflation are healthy, but as population growth declines, it has been very difficult to achieve any meaningful inflation.
We should keep in mind that slowing population growth in Europe and Japan has resulted in an inflation rate that is non-existent and even deflationary. Countries like Germany and Japan recently resorted to negative interest rates to boost their respective economies. One day in the future, the United States may have to do the same by going into negative interest rates too, to support its economy.
Listen to what the Bond Markets are Saying:The bond markets are rarely wrong, especially the long term ones, and they all indicate that the lack of inflation - and continued deflation for some economies - will persist. Let us look at the long-term chart trend.
Below is the 10-year US Treasury Bond Yield Since 1962We can notice that we have been so far
in a 29-year period of interest rate declines, and this trend is not changing.
Even worst for the 10-year German bond yieldsThe 10-year yields of the German bonds have been in straight declines since the 2007-2008 financial crisis, and the yields dipped below zero in 2018 following the Brexit scare.
The Hunt for Yield Will ContinueIn my opinion, counting on growth alone when it comes to investing is no longer a viable option. In an environment where growth is slow, inflation is low, and interest rate trends continue to decline, the hunt for high yield will continue, and will become even stronger.
Not all high yields are equal in the current environment. High Yield stocks and securities that rely less on economic growth are set to outperform. Asset classes such as quality long-term bonds, preferred stocks, and high-yield/low-growth stocks are the best positioned to outperform. Another added advantage of securities such as preferred stocks and bonds is lower price volatility.
The challenge is to achieve high yields of +9% by increasing allocation to more conservative picks, but we can do it by pairing higher-yields (of +10%) that carry a higher-volatility, with high-yields (of +7%) with lower volatility. We will have more on how to pair dividend stocks to achieve +9% yields with lower price volatility in a new report soon to our members.
Bottom LineWith central bankers across major economies putting their weight to rekindle economic growth, recession risks will be reduced and pushed back till the year 2022 or later.
This will also support equity prices, and I believe that the S&P 500 index (while it remains technically challenged), should reach well above the 3000 level in 2019. The year 2019 should be a good year for equities.
Growth stocks will recover some of their recent losses and should see renewed interest. However lower economic growth and low inflation means that the hunt for yield will continue. High-dividend stocks and sectors which have had a very strong start in 2019 will continue to outperform.
Our strategy for the year 2019 is to remain well-diversified into the high-yield stocks and sectors while increasing allocation to preferred stocks, and bond-like stocks (such as ATAX recently). We have new recommendations coming soon. Stay tuned.