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Trading  | April 5, 2018

With global economic growth having having hit a notable plateau in recent months in both survey-based takes of the economy, as well as among the more important, hard data, as shown in the following chart summarizing Citi’s G-10 economic surprise index, which after peaking at the start of the year has tumbled into negative territory in just a few months…

… many traders are increasingly concerned if, whereas corporate profits are still strong, they won’t slide into the second half of the year as the economic slowdown spreads to the corporate top and bottom line.

To answer the question of “what to do when global growth is moderating”, here is Bloomberg Market Live commentator Ye Xie with some thoughts and ideas on how to trade this often treacherous inflection point.

* * *

What to Do When Growth Is Moderating? Stop Worrying: Macro View

It appears that the synchronized global growth since mid-2016 is finally coming off the boil. Unless it turns into a nasty meltdown, risky assets from stocks to junk bonds should do just fine.

A flattening Treasury yield curve is what one should be expecting, if history is any guide. While trade spats grab investors’ attention, it matters to the markets only when it starts to affect the economies.

To that end, we are seeing signs of fatigue after nearly two years of surging growth. Manufacturing activity slowed in 19 of 28 economies tracked by JPMorgan and Markit in March, particularly in the euro area. In February, only 10 countries had sequential slowdowns.

That shouldn’t be surprising. After all, economies cannot grow above their long-term potential forever. The question is what to do when growth momentum peaks. Given the synchronization, U.S. manufacturing can serve as a proxy for the health of the global economy. Let’s look at periods when the three-month average of the U.S. ISM Manufacturing Index slowed from the previous month, but held above the long-term average of 53.

  • For the S&P 500, the median return since 1950 was -0.1% during the month when PMI slowed. Stocks gained a total of 2.1% over the next three months and 7% in 12 months. (Note that the current trailing P/E of 15x is lower than the median 16.5x during the periods of growth moderation)
  • Global stocks performed well. The MSCI All-Country World Index gained 12% in 12 months. Equities rose in 74% of months in the one-year horizon. The EM benchmark did even better, with a median 12-month gain of 15%
  • Ten-year yields rose slightly, but what was more noticeable, the curve flattened consistently. Yields on 10-year rose 3 bps in three months and 11 bps in a year. The 2s10s curve narrowed 14 bps and 36 bps during the same periods, respectively

It’s likely that both will occur this time: a gradual normalization of term premium would push long-end yields higher somewhat, while yields on the short end rise even faster as Fed keeps tightening.

What about the credit market?

  • High-yield bonds returned 7.5% in 12 months, while EM government dollar bonds gained 10%. One caveat: yields are much lower than the historical average. At 6.2%, the current junk bond yields are more than 230 bps lower than the median in the sample. EM bond yields are about 90bps less than the historical level

As for the dollar, it fell slightly against both the euro and yen in three months, but gained about 1% and 3% in 12 months. So a note of caution for dollar bears.

As always, the average performance masked wide ranges of returns. And the trading environment has gone through different phases, suggesting limitations for the effort to draw broad conclusions. Still, it’s probably not far-fetched to suggest that as long as the economy is doing fine and no recession is in sight, a moderate slowdown won’t be a disaster for investors.

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