Morgan Stanley
  • Wealth Management
  • Oct 14, 2019

Economic Growth May Remain Elusive

While the market is responding positively to recent headlines on trade and Fed policy, these moves are unlikely to stimulate much economic growth.

Markets have essentially taken investors on a rollercoaster ride for most of the past two years. Even after Friday’s strong gains, the S&P 500 has mostly remained in a narrow range between 2,800 and 2,950 since January, 2018. Below the surface, most U.S. stocks are down in that time frame and non-U.S. stocks have fared worse (down 17% on average).

Yet investors have remained resilient, hopeful that policies around trade and interest rates that contributed to the global economic slowdown and weak corporate earnings growth would eventually be reversed, leading to new growth.

They may be waiting a long time. While some key economic policies are being unwound, fueling optimism, those moves are unlikely to result in the kind of growth investors seem to be expecting.

First, consider trade relations with China. Last Friday, the S&P 500 gained more than 1%, in part due to signs of progress on China-U.S. trade negotiations. But the best case scenario may be a pause in tariff escalation, not a rollback. Such pauses are often temporary, with minimal impact on GDP growth.

Second, let’s look at Federal Reserve policy. After raising interest rates repeatedly in 2017 and 2018, the Fed reversed course this year and started lowering rates to counter signs of economic weakness—in part due to a trade slowdown. Investors expect more rate cuts, but  they might not be enough to stimulate growth.

Consumer credit, which fuels spending in key sectors, may be tapped out. For example, auto loan debt has doubled in the past 10 years, with the average loan duration at 69 months—an all-time high. Credit card charge-offs, reflecting customers who are unable to make their payments, has risen to 3.74%, the highest level since 2012.

Meanwhile, business spending has also lagged behind forecasts that factored in typical impact from lower interest rates. It seems that Fed policy may be approaching the point of “pushing on a string,” when lower rates have limited ability to spur the economy.

As the current business cycle ages, I think investors should remain cautious. However, if you believe that a U.S.-China trade deal and more Fed stimulus will create the kind of economic growth that could lead to more market gains, my suggestion, which may seem counterintuitive, is to add exposure to emerging markets, which are inexpensive relative to U.S. growth stocks and likely to benefit from a potential trade deal and more Fed easing.