As we advance through 2019 memories of the rapid equity sell-off which started in quarter four 2018 are fading. The US S&P 500 equity index is making new all-time highs and other world equity markets are producing decent positive returns.
It is strange therefore to see bonds also doing well. Typically, both markets (equities and bonds) tend to be negatively correlated i.e. as equity prices go up bond prices go down and vice versa. When this happens, it points to economic growth improving or deteriorating. With both markets doing well one of them is surely wrong. What is going on?
We know for certain (read our article on the Phillips Curve) that the jobs market is in rude health. Even in Europe, where jobs growth has lagged, unemployment is continuing to improve. Wages are picking up and inflation is tame. Moreover, central banks in the main developed economies are struggling to hit their inflation targets. This helps to explain why bond prices have risen and yields have fallen. At the same time the Fed and the European Central Bank (ECB) are contemplating cutting interest rates again. This is encouraging investors to buy risk assets like equities, believing economic growth will improve. Hence, bond and equity markets have risen together.
Looking back, one area where growth prospects have been dented is manufacturing. When it comes to the UK, China and Europe, business sentiment has been harmed by trade tensions. A softening of investment intentions is well entrenched. However, the US is bucking the trend. Data released earlier this week shows US manufacturing output continuing to increase. The improvement in output is being driven (pardon the pun) by an increase in the automotive sector. This defies economists’ expectations which had forecast a reduction in output due to the on-going US-China trade uncertainty.
US Manufacturing Output Year on Year
Source: Bloomberg, July 2019
Aside from manufacturing activity picking up, the real engine of growth for the US, and the world, is US household consumption. In this regard US retail sales data is important. The latest readings show retail sales growth exceeding expectations. Americans are loosening their purse-strings, a sign that consumers remain confident.
Headline, or broad, retail sales climbed 0.4% from the month prior, mirroring growth in May. This, again, exceeded economists’ expectations of a 0.1% rise. Further, control-sales, a metric used to measure retail sales minus volatile products such as food, gas and building materials, rose 0.7%, eclipsing the previous month. This measure is often considered as the most accurate representation of underlying sales strength. Therefore, the most recent information we have reflects an even healthier retail sector than indicated by the broad measure.
US Broad & Control Retail Sales Month on Month
Source: Bloomberg, July 2019
The fact that bond and equity prices have moved higher together is a function of non-inflationary growth and easing monetary policy conditions. A pick up in key economic fundamentals are being predicted. If productivity improves across economies this will allow wages to rise without companies having to push through price rises to compensate; keeping inflationary pressures in check. Pretty good when you think about it.
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