“I don’t like losses, sport. Nothing ruins my day more than losses,” said Gordon Gekko.
That disdain for market declines expressed by the fictional corporate raider played by Michael Douglas in the 1987 movie “Wall Street,” remains true for investors today. And Liz Young director of market strategy at BNY Mellon, says that a sharp downturn of major equity indexes could actually tip U.S. expansion, currently in its record 11th year, into recession.
The strategist’s view underscores the belief that deteriorating investor confidence could catalyze an economic slowdown, rather than a recession inciting a n equity selloff.
“There is a fragility in the markets right now, and a chance that we get a piece of news that’s negative that drives sentiment down to a lower level, and if that continues and drives a risk selloff, the market could send us into recession,” Young told MarketWatch in a Friday interview.
Young said the market is in a vulnerable state which stems from the fact that the S&P 500 index SPX, -0.49% has risen more than 19% year-to-date even as earnings growth has been flat, while corporations are increasingly holding off on capital expenditures.
“The market returns this year have been driven by macro factors and central bank support,” she said. “Companies aren’t in control as much as macro rhetoric, and we could have any number of geopolitical events that come in and change sentiment.”
Young places a 30% chance of a recession spurred by a breakdown in sentiment.
In other words, she holds a higher chance that the U.S. economy will withstand pressures from slower global growth and weaker corporate investment driven by trade war concerns, and that the stock market will continue to drift higher into 2020.
But this rosier outcome, and whether equity markets can overcome recent jitters and break out to new highs, may hinge on what the Federal Reserve does in the coming months, she said.
Fed Chairman Jerome Powell announced the second interest-rate cut of the year on Wednesday, but during his news conference “he really did soften investor expectations for there being that many more cuts down the road,” Young said. The rate-setting Federal Open Market Committee voted 7-to-3 to cut rates by 25 basis points, marking the greatest number of dissenting voters since 2016, and suggests that gathering consensus around another cut this year won’t be easy.
“With an economy that’s strong and data that continues to be stable and a manufacturing slowdown that isn’t a severe, I think it makes sense to not overpromise,” she added.
Yet Young predicts that the FOMC will, in fact, cut one more time and that such a move, following tempered expectations for more easing, could be just what the market needs to find its footing. “From an investor perspective, if the fed-funds fund rate is below the two year, it makes sense for the yield curve to steepen slightly.”
The federal-funds rate now sits between 1.75% and 2% after the Fed’s cut, while the two-year U.S. Treasury note TMUBMUSD03M, -0.81% was at 1.711% late Friday in New York.
The closely watched yield curve, or the difference in yield between longer-dated U.S. government debt and its shorter-dated counterpart, has been inverted since around May, with 3-month TMUBMUSD03M, -0.81% yielding 15 basis points more than that of the 10-year Treasury note TMUBMUSD10Y, -3.45%. Because investors usually demand a richer yield for lending money over a longer period, a so-called yield-curve inversion, which has preceded past recessions, has inspired trepidation among investor.
Though Young said that “risks have been skewed to the downside,” she argued, however, that “it doesn’t necessarily mean the expansion has to end.” She suggested that investors don’t abandon equity markets out of fear of recession, though taking a more defensive posture within the stock market could make sense, depending on risk appetite and an investor’s unique investing time horizon.
“We continue to look for risks that will end this expansion, and either it’ll probably be something we’re not looking for or its just not going to happen,” she said. “We need to spend less time looking around the corner for what’s going to happen today, or we run the risk of missing out on potential upside.”
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