To my clients:

It was a down week for North American stock markets with the Canadian TSX finishing down 0.7%; the U.S. Dow Jones Index down 1.0%; and the U.S. S&P 500 down 1.4%.

Another busy week, and volatility continues. On the “hard” economic data front, there were two noteworthy U.S. releases:

• At 209,000 weekly jobless claims, this metric again turned lower and came in better than expectations (I emphasized the word “better”, because in the case of jobless claims, lower is indeed better… not so with the monthly Employment Report, where higher is better). Overall U.S. employment conditions remain strong and continue to contradict the message being sent by the inverted yield curve. In other words, employment conditions do NOT confirm recessionary fears. The trend in weekly jobless claims remains RBC’s second most watched indicator when assessing the likelihood of recession.
• The U.S. Manufacturing and Services Purchasing Managers Indices (PMI’s) were released, and both came in worse than expected. I should emphasize that these are NOT the more widely followed monthly ISM Manufacturing and Services indexes that I regularly comment upon. The PMIs, while important, are less tracked than the ISM comparables. Nonetheless, the signals sent are concerning, and should definitely be watched for further deterioration. Of particular note is the fact that the Manufacturing PMI fell to 49.9, which is just slightly into contractionary territory (50.0 is the demarcation line between expansion and contraction). Historically, the U.S. has been able to sustain brief periods of mild contraction in the manufacturing sector without the economy as a whole falling into recession and, in fact, has done so a handful of times the past decade. The more widely followed ISM releases in two-week’s time will be particularly important to assess.

Elsewhere, it should be no surprise that Chinese industrial production continues to slow. While it did increase 4.8% year-over-year in the month of July - an expansion rate that the rest of the industrialized world would be ecstatic to achieve - it was a full 1.0% below market expectations for a 5.8% reading, and marks the weakest gain since 2002. Two thoughts here: 1) the 1.0% miss is significant and troublesome, but not surprising given the ongoing trade conflict; and 2) the trend in all measures of Chinese economic data are in secular decline from absolutely torrid mid-teens (and beyond) percentage growth rates of decades past, so the “lowest reading since 2002” in and of itself is not necessarily surprising… but again, the significant 1.0% miss vs. expectations is.

And in Germany, the country recorded economic contraction in Q2 2019. As with much of the recent economic data, this too is concerning. But here too I’d point out that, by my count, Germany has had 9 quarters of sporadic contraction in the decade since the financial crisis of 2008. Yet said contractions have done little to push the U.S. off its own growth path over the same 10 year period.

Overall, the trend in economic data is definitely turning for the worse, and should not be excessively rationalized. That said, it remains my and RBC’s base case that the U.S. is not imminently threatened by recession. This is also the base case of the U.S. Federal Reserve, with Chairman Jerome Powell saying as much in his opening remarks this morning at the annual central bank symposium in Jackson Hole, Wyoming. But the prospect of recession is certainly building, and I am monitoring events with another reduction in equity exposure being actively considered.

With respect to Mr. Powell’s comments in Jackson Hole, he reiterated his oft-used phrase that the Fed would “act as appropriate to sustain the expansion” while acknowledging the “deteriorating” global economic outlook. Of particular interest to myself was Powell’s comment that the Fed is “asking (itself) whether we should expand our toolkit (emphasis Nick’s)”. As Powell was making these comments, markets reacted favourably, turning what had been a mildly negative market in the morning (on the back of China imposing its own counter-tariffs on $75 billion worth of U.S. goods) into a mildly positive market. But then, the ‘Tweeter in Chief’ entered the fray with, amongst a great many other things China-related, the following:

Our great American companies are hereby ordered to immediately start looking for an alternative to China, including bringing your companies HOME (emphasis Trump’s) and making your products in the USA.

Whether Trump has the authority to follow-through on this “order” is open to debate, although I suspect that if push came to shove he certainly could do so. Further, note that the order commands companies to “start looking” – in other words, the tweet and the order are of no immediate consequence. But certainly the trade “war” (which it can certainly be called now) has been ratcheted up yet again.

However, I remain mindful of the power of the Federal Reserve, and the morning comments of Mr. Powell which seemed to have been immediately forgotten in the wake of President Trump’s tweet. As I wrote a number of weeks ago, I feel that Trump is intentionally ratcheting up the trade rhetoric with at least the partial goal of forcing the Fed’s hand. That at least another 0.25% rate cut is coming in September (or sooner) seems a certainty. As with the last Fed Policy announcement, the more pertinent question might be whether a 0.50% cut (or greater) might be in the cards, OR another round of quantitative easing (owing to the underlined “expanded toolkit” comment noted above), OR a combination of all these.

To reiterate, I remain of the view that U.S. recession is not imminent. The U.S. Federal Reserve is of the same view. So too is Brian Moynihan, CEO of Bank of America who stated last week that “the biggest recession risk is the fear of recession”. His point is that economic data has yet to point to a recessionary outcome, but that talk of recession could damage business and consumer confidence to a degree that recession becomes a self-fulfilled prophecy. I will, as always, monitor very closely. I reiterate that I am actively considering yet another equity reduction in client portfolios. But, I am not there yet, and suspect that the Federal Reserve may soon make a decisive gambit of its own.

That’s all for this week. All the best,

Nick

Nick Scholte, CIM, FCSI

Vice-President & Portfolio Manager
RBC Dominion Securities Inc. │ Tel: 604.257.7569 │ Fax: 604.235.9950
3200-1055 West Georgia │ Vancouver, BC │ V6E 3P3
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