New year, same story: Potential for Market Shocks to the Upside and Downside

On the latest edition of Market Week in Review, Quantitative Investment Strategist Abraham Robison and Research Analyst Brian Yadao discussed the latest manufacturing data from the U.S. and Europe. They also reviewed equity and bond market performance in 2019, and chatted about key elements to this year’s market outlook.

U.S. manufacturing activity hits 10-year low

The slump in U.S. manufacturing continued in December, Robison said, with the Institute for Supply Management (ISM)’s manufacturing index falling to 47.2. That number is the lowest since June 2009, he noted, explaining that a reading below 50 indicates contraction.

“December marked the fifth straight month of contraction for the U.S. manufacturing sector,” Robison stated, adding that the latest PMI (purchasing managers’ index) data from Europe also showed contractionary conditions. Simply put, the manufacturing sector has been in a slump for an extended period of time, he said.

In spite of this, equity markets have continued to perform quite well, Robison noted, with major indexes notching record highs throughout much of December and again on Jan. 2. However, escalating tensions between the U.S. and Iran bear careful watching, following the Jan. 3 U.S. airstrike that killed a top Iranian military commander, Robison said. “A key question for markets will be whether this situation escalates to the point where it impacts energy prices, which in turn could impact macro-economic indicators,” he explained.

Low unemployment and low inflation: The recipe for a Goldilocks scenario?

Looking back at 2019, Robison characterized it as an amazing year for equity markets, despite the China-U.S. trade war and degrading economic fundamentals. Why?

“The trade war managed to depress prices a little bit, and the Fed reacted by cutting interest rates three times. So, we ended the year in a Goldilocks scenario of low unemployment and low inflation—and equity markets do very well in this type of environment,” he explained.

The bond market also performed well in 2019, Robison said, with prices rising as yields fell. After being in an inverted state for much of the year, the U.S. Treasury yield curve un-inverted in the fourth quarter, he added.

Key elements to 2020 market outlook

In 2020, there’s potential for market shocks to the downside and upside, Robison said. If inflation were to increase, it’s possible the U.S. Federal Reserve could have a harder time fighting any financial market instability, he noted, as the central bank wouldn’t be able to justify cutting rates.

On the other hand, potential improvements in economic fundamentals could lead to an upside in markets, Robison said—assuming inflation and unemployment remain low. “This would likely lead to higher equity prices in 2020,” he stated.

Whatever transpires this year, Russell Investments’ Market Week in Review team will strive to keep you informed with expert insight and analysis—every Friday, every week.