Baldwin Investment Management

Watchful…

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Above is a useful tool to quickly determine if the U.S. is in or is about to enter a recession, which might herald a sharp downturn (i.e. >20%) in equity prices. There are seven indicators (the yield curve, earnings, inflation, etc.) which are highlighted as important markers and the history of these indicators’ utility during past recessions dating back to 1973. As can be seen, it is only the yield curve which is presently flashing a recessionary caution. The others are either neutral or still in expansionary mode. In particular, inflation is quiet, employment is strong and loan delinquencies are low. Corporate earnings have been surprisingly robust through the second quarter of 2019 – but do look like they will be slowing, at least temporarily in Q3. Housing activity has never recovered its old records from before the “Great Recession”. It has not been its usual strong contributor to economic growth in this recovery. That is the bad news. The good news is that housing is not overextended, and we must all remember that it was the housing/real estate bubble that drove the U.S. and the world into the

“Great Recession” beginning in 2007. So, we think housing being neutral is a good “thing”. However, manufacturing is “sputtering”. Tariffs and trade fights are creating uncertainty and uncertainty is the enemy of decision making. Hesitation has crept into the “C” suites and boardrooms. Deciding not to decide is the new modus operandi. This must change because the American consumer, who has done a terrific job in bolstering the U.S. economy, ultimately will need some help from companies’ capital expenditures to support the economy.

Now let’s focus on the yield curve, which is flat or inverted (i.e. short maturity bonds yield more than long maturity bonds, which is counterintuitive). Historically, but not with a lot of timing accuracy, an inverted yield curve has been predictive of an impending recession. When that predicted recession might occur has been problematic. Today, however, bond markets around the world have been highly manipulated by central banks, like the American Federal Reserve (Fed). In order for the world to extricate itself from the “Great Recession”, the Fed, as did the European Central Bank (ECB), as did the Bank of England (BOE), as did the Bank of Japan (BOJ), executed some pretty extraordinary monetary policies to get the worlds’ economies “out of the ditch”. The central banks became “major players” in fixed income markets and distorted those markets. So, we are not at all sure that an inverted yield curve today is as meaningful an economic indicator as it had been. In short, the “dashboard” would seem to strongly suggest that a recession is not nigh – yet.

Other Things…….

The dollar, for those who like a strong currency, is the envy of the world. Most currencies around the globe this year have depreciated against the greenback, primarily due to higher U.S. interest rates and an economy, while not sizzling, growing better than most. Unfortunately, the strong dollar has hurt American trade, making exports of U.S. goods more expensive and slowing U.S. GDP.

The Middle East has become trickier all of a sudden with an attack by Iran on a major Saudi oil facility. The damage is extensive, and the flow of oil will certainly be constricted to some extent for who knows how long. The price of oil lurched upwards in late September, but most traders are waiting for the “next shoe to drop”. Currently the world is well supplied with oil – so market reaction has not been too severe. But this is an important story still unfolding. Stay tuned. Too high an oil price is not good for the world economy.

China and the U.S. are still grappling about their trade relationship. Tariffs have been instituted on both sides which have had deleterious effects on economic growth in both countries and elsewhere in the world. What was supposed to be “easy” according to our politicians (winning a trade war) has been found to be difficult. China’s economy is slowing and could well register growth of 5% this year – well down from 2018. The American economy is also being hurt, especially in the farmlands and in manufacturing. This needs to get solved and markets still expect it to get solved – but the chances of a prolonged trade war have increased, which will hurt business in the short term until new supply lines are well established.

Political bombast out of the UK has scaled new heights as Boris Johnson has become Prime Minister. He has quickly lost three crucial votes regarding Brexit and has been unanimously rebuked by the UK Supreme Court regarding the suspension of Parliament. Now there is open debate about a No Confidence vote regarding Johnson’s government. Parliament vows to restrain his seemingly fantastic efforts to leave the European Union (EU) without a deal by Halloween. Prime Minister Johnson has declared that he will not ask for an extension and that the UK will leave on October 31 – deal or not, despite Parliament having passed a law saying he must get an extension if there is no deal by mid-October. It would seem that Boris is aiming to break the law if he “sticks to his guns”. Imagine that – the CEO of a sovereign land breaking its law. This is “populism” run amuck!

The “love affair” with Kim Jung Un of North Korea appears to have cooled. Kim is firing off missiles and insults. So far there is no reaction from the U.S. – but there is also no progress.

NAFTA 2.0 is still not law. It is caught in the halls of Congress. Advancements are being made, but the deal is not done. Japan has supposedly come to a trade agreement. Details of this will appear in the near future.

“Fed Bashing” has become a “thing”. Past American administrations have infrequently “taken shots” at Fed policy and Fed Governors. Recently, the pace of Fed criticism has picked up, the language used is coarser and the political angle seems apparent. Monetary policy is best run when it is not politicized. An independent Fed, as perceived by the markets, is essential for smooth functioning markets. If investors do not believe that monetary policy is being managed for the good of the economy alone, then a “political risk premium” will be priced into securities.

Lastly, the Speaker of the House announced that the House of Representatives would start a formal impeachment inquiry of President Donald Trump. Legislative progress on any particular front could well be stunted for the foreseeable future.

The above survey of “Other Things” is not meant to scare, but to put people on notice that there are disturbances which could morph into something more serious, affecting markets around the globe. So far, it has been right to discount heavily this “noise” and focus on the fundamentals, which have been surprisingly good. But one cannot become complacent.


Above is a useful tool to quickly determine if the U.S. is in or is about to enter a recession, which might herald a sharp downturn (i.e. >20%) in equity prices. There are seven indicators (the yield curve, earnings, inflation, etc.) which are highlighted as important markers and the history of these indicators’ utility during past recessions dating back to 1973. As can be seen, it is only the yield curve which is presently flashing a recessionary caution. The others are either neutral or still in expansionary mode. In particular, inflation is quiet, employment is strong and loan delinquencies are low. Corporate earnings have been surprisingly robust through the second quarter of 2019 – but do look like they will be slowing, at least temporarily in Q3. Housing activity has never recovered its old records from before the “Great Recession”. It has not been its usual strong contributor to economic growth in this recovery. That is the bad news. The good news is that housing is not overextended, and we must all remember that it was the housing/real estate bubble that drove the U.S. and the world into the

“Great Recession” beginning in 2007. So, we think housing being neutral is a good “thing”. However, manufacturing is “sputtering”. Tariffs and trade fights are creating uncertainty and uncertainty is the enemy of decision making. Hesitation has crept into the “C” suites and boardrooms. Deciding not to decide is the new modus operandi. This must change because the American consumer, who has done a terrific job in bolstering the U.S. economy, ultimately will need some help from companies’ capital expenditures to support the economy.
Now let’s focus on the yield curve, which is flat or inverted (i.e. short maturity bonds yield more than long maturity bonds, which is counterintuitive). Historically, but not with a lot of timing accuracy, an inverted yield curve has been predictive of an impending recession. When that predicted recession might occur has been problematic. Today, however, bond markets around the world have been highly manipulated by central banks, like the American Federal Reserve (Fed). In order for the world to extricate itself from the “Great Recession”, the Fed, as did the European Central Bank (ECB), as did the Bank of England (BOE), as did the Bank of Japan (BOJ), executed some pretty extraordinary monetary policies to get the worlds’ economies “out of the ditch”. The central banks became “major players” in fixed income markets and distorted those markets. So, we are not at all sure that an inverted yield curve today is as meaningful an economic indicator as it had been. In short, the “dashboard” would seem to strongly suggest that a recession is not nigh – yet.

Other Things…….
The dollar, for those who like a strong currency, is the envy of the world. Most currencies around the globe this year have depreciated against the greenback, primarily due to higher U.S. interest rates and an economy, while not sizzling, growing better than most. Unfortunately, the strong dollar has hurt American trade, making exports of U.S. goods more expensive and slowing U.S. GDP.
The Middle East has become trickier all of a sudden with an attack by Iran on a major Saudi oil facility. The damage is extensive, and the flow of oil will certainly be constricted to some extent for who knows how long. The price of oil lurched upwards in late September, but most traders are waiting for the “next shoe to drop”. Currently the world is well supplied with oil – so market reaction has not been too severe. But this is an important story still unfolding. Stay tuned. Too high an oil price is not good for the world economy.
China and the U.S. are still grappling about their trade relationship. Tariffs have been instituted on both sides which have had deleterious effects on economic growth in both countries and elsewhere in the world. What was supposed to be “easy” according to our politicians (winning a trade war) has been found to be difficult. China’s economy is slowing and could well register growth of 5% this year – well down from 2018. The American economy is also being hurt, especially in the farmlands and in manufacturing. This needs to get solved and markets still expect it to get solved – but the chances of a prolonged trade war have increased, which will hurt business in the short term until new supply lines are well established.
Political bombast out of the UK has scaled new heights as Boris Johnson has become Prime Minister. He has quickly lost three crucial votes regarding Brexit and has been unanimously rebuked by the UK Supreme Court regarding the suspension of Parliament. Now there is open debate about a No Confidence vote regarding Johnson’s government. Parliament vows to restrain his seemingly fantastic efforts to leave the European Union (EU) without a deal by Halloween. Prime Minister Johnson has declared that he will not ask for an extension and that the UK will leave on October 31 – deal or not, despite Parliament having passed a law saying he must get an extension if there is no deal by mid-October. It would seem that Boris is aiming to break the law if he “sticks to his guns”. Imagine that – the CEO of a sovereign land breaking its law. This is “populism” run amuck!

The “love affair” with Kim Jung Un of North Korea appears to have cooled. Kim is firing off missiles and insults. So far there is no reaction from the U.S. – but there is also no progress.
NAFTA 2.0 is still not law. It is caught in the halls of Congress. Advancements are being made, but the deal is not done. Japan has supposedly come to a trade agreement. Details of this will appear in the near future.
“Fed Bashing” has become a “thing”. Past American administrations have infrequently “taken shots” at Fed policy and Fed Governors. Recently, the pace of Fed criticism has picked up, the language used is coarser and the political angle seems apparent. Monetary policy is best run when it is not politicized. An independent Fed, as perceived by the markets, is essential for smooth functioning markets. If investors do not believe that monetary policy is being managed for the good of the economy alone, then a “political risk premium” will be priced into securities.
Lastly, the Speaker of the House announced that the House of Representatives would start a formal impeachment inquiry of President Donald Trump. Legislative progress on any particular front could well be stunted for the foreseeable future.
The above survey of “Other Things” is not meant to scare, but to put people on notice that there are disturbances which could morph into something more serious, affecting markets around the globe. So far, it has been right to discount heavily this “noise” and focus on the fundamentals, which have been surprisingly good. But one cannot become complacent.

Predictions for 2019

  1. U.S. inflation, using the Fed’s favorite measure, will “remain around” 2%, giving the Fed some “room” to pause interest rate increases.
    No – Inflation <2%, & the Fed started cutting interest rates.
  2. U.S. GDP growth 2%-3%; rest of worl range 1% (think Eurozone) – 7% (think India).
    Yes
  3. U.S. unemployment will stay low.
    Yes
  4. U.S. corporate profits +6%-9%.
    Yes – Q1 & Q2 corporate earnings were stronger than expected. Q3 might be a bit “light.”
  5. West Texas Intermediate crude oil will recover to a range of $60-$70/barrel.
    Yes – Still think so, Middle East tensions are putting “risk” back into investor equations.
  6. The dollar will drift lower.
    No – The dollar has been strong due to relatively higher interest rates and a relatively strong economy.
  7. U.S. consumer sentiment will stay strong.
    Yes
  8. Corporate chiefs will become more timid spending money; state governments will spend more.
    Yes – Trade worries are making decision makers indecisive.
  9. The U.S. and China will do a trade deal.
    Yes – Still think so, but brinksmanship is apparent.
  10. Equity markets will do well.
    Yes

A Final Thought


The opinions expressed in this Commentary are those of Baldwin Investment Management, LLC. These views are subject to change at any time based on market and other conditions, and no forecasts can be guaranteed.

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