Equity markets bounced on Tuesday, the catalyst on hopes that the trade war between East and West might be thawing, was soon forgotten on Wednesday as investors ran for the hills. The trigger for the sharp correction that led to a fall of 3% in US leading equity indexes was the yield in the ten-year maturing bond falling below that of the two years. According to Piper Jeffery research, the inversion of the two- and ten-year yields has preceded a recession over the past 40 years. The probability of a US recession within the next six months has risen to over 50%. In response, the bond market now predicts the Fed will cut rates up to four times this year.
Although the data for Europe remains weak pretty much across the board, there was some slightly encouraging economic data for the UK economy in the form of retail sales on Thursday. The pound which remains very unloved recovered a little ground on the news. Jeremy Corbyn’s attempts to unite the two main parties to form a caretaker government to prevent a no-deal Brexit seems to be succeeding. At least uniting everyone that he is not the man or the task.
Equity markets may have already gone some way to where the bond markets are forecasting. The FTSE 100 is lower by about 8% than where it was a year ago. The S&P 500 were it in August 2018 and the Stoxx 50 likewise lower than where it was this time last year. Volatility may have increased, but stock markets have not. The Russell 2000 index of smaller companies has fallen over 10% year to date.
Equity analysts continue to downgrade earnings estimates and now predict the third quarter of shrinking company earnings. This will not encourage equity fund managers. Although, at present, analysts still forecast a recovery in the fourth quarter. According to Factset forecasts for year on year growth in earnings in 2019 was 6%, at the start of the year, it is now almost flat. Just as analysts get overly bullish when economies look good, they can get too bearish on the way down. At some point, they will do so this time. The trick is trying to gauge that point.
With three major stock market corrections in the past twenty years, the most recent being the infamous one in 2008, there is an almost expectation of the next one. As equity markets have marked time over the past year, they may continue to do so. Goldilocks porridge may not be just the right temperature anymore, but it may not yet be stone-cold either.