Download the Schwab app from iTunes®Get the AppClose

Global Stocks Mid-Year Outlook

Key Points
  • Stock markets around the world will likely have to contend with slowing global economic growth. Leading indicators point to an increasingly vulnerable world economy that may be worsened by shocks from trade tariffs and other factors. 

  • The heightened potential for reversals in long-term market performance trends may catch unprepared investors by surprise. 

  • Investors should ensure they have an appropriate amount of broad international portfolio exposure, including both emerging and developed markets, to benefit from opportunities for performance and diversification.

In the second half of the year stock markets around the world will likely have to contend with slowing global economic growth. Leading indicators point to the rising risk of recession. Pressures are building up that may weigh on stock markets, including: 

  • escalating trade tariffs between the U.S. and China 
  • the United Kingdom heading toward a “hard” Brexit
  • renewed U.S geopolitical tensions with Venezuela, Iran and North Korea 
  • the lagged effect of interest rate hikes by the Federal Reserve
  • the slump in corporate earnings

Individually, these “straws” may not be enough to break the market’s back, but they are piling up at a time when the global economy is vulnerable to shocks. This may make for a more challenging second half of 2019 for unprepared investors.

Camel cartoon

The likelihood of each of these potential shocks, and the affect they may have on consumer confidence, business spending, and financial conditions, are changing constantly and are hard to forecast. In our Mid-Year Outlook we analyze the current heightened vulnerability of the global economy to any shock, or series of shocks. Specifically, we examine the vulnerabilities reflected in consumer confidence, business’ outlook for manufacturing, CFO expectations, leading economic indicators, and the U.S. yield curve. We will then turn to how investors can be best prepared for the second half of 2019.

High consumer confidence 

The economies of the United States, European Union, and Japan are the first, second and fourth largest economies in the world, respectively (International Monetary Fund). These economies are driven primarily by consumer spending and together account for more than half of the world’s economy. The currently high consumer confidence in these countries might imply that the global economy may be resilient to a downturn, but history shows just the opposite. As you can see in the chart below, consumer confidence in the U.S. and Europe may have already peaked for this cycle at a level similar to that which preceded the past global recessions of 1990-91, 2001, and 2008-09.

Consumer confidence at levels that preceded past recessions

US consumer confidence vs Europe consumer confidence

Source: Charles Schwab, Bloomberg data as of 6/20/2019.

Japan is also showing signs that consumer confidence may be past its peak for this cycle. Consumer confidence seems to be retreating from its recent peak of -10, a level that preceded past recessions in Japan, as you can see in the chart below.

Japan’s consumer confidence past the peak for this cycle?

Japan consumer sentiment

Source: Charles Schwab, Bloomberg data as of 6/20/2019.

In economies driven by consumer spending, high consumer confidence may seem like a positive. But, confidence that is low and rising tends to be more consistent with a brighter growth outlook than when it is high and starting to fade. 

Manufacturing recession

Manufacturing often acts as a leading indicator for all business types and tends to signal the direction of corporate earnings growth. The widely-watched global manufacturing Purchasing Managers’ Index has slipped below 50, the level that marks the threshold between growth and contraction, and has fallen for a record 13 months in a row through May, as you can see in the chart below.

Global purchasing managers’ index falls for 13 months in a row

months of recessions

Source: Charles Schwab, Factset data as of 6/16/2019.

Global leading indicator at recession threshold

The composite leading index (CLI) from the Organization for Economic Cooperation and Development (OECD), a well-known economic think tank, has fallen to 99.0—a threshold that in the past has marked the line between growth and recession for the world economy, as you can see in the chart below.

World leading economic indicator at key recession threshold

OECD LEI

Source: Charles Schwab, Bloomberg data as of 6/16/2019.

CFO see a recession in 2020

The June 2019 survey of Chief Financial Officers shows that most CFOs expect a recession in 2020, as you can see in the chart below. Debating the accuracy of their forecast is less important than what actions CFOs may take in response to this outlook. For example, the survey also showed that CFOs are pulling back on business investment plans for the coming 12 months, which may weigh on growth.

Most CFOs expect a recession next year

CFO confidence

Source: Charles Schwab, Duke CFO magazine cfosurvey.org data as of June 2019.

Yield curve inversion

The U.S. Treasury yield curve continues to invert, with the yield on the 10-year note slipping below the yield on the 3-month bill. Historically, this has acted as an indicator of a global recession on the horizon, and that stocks may be near a cycle peak, as you can see in the chart below.

Yield curve inverts again

10-year minus 3-month Treasuty spread vs MSCI World Index

Source: Charles Schwab, Bloomberg data as of 6/16/2019.

Can central banks save the day?

Investors seem to have pinned their hopes on the Federal Reserve. The stock market rally in the first half of the year has been at least partially fueled by the Fed signaling an end to the current rate hike cycle and hinting at the possibility of rate cuts in the second half of 2019. Other central banks may also cut rates to ease financial conditions in second half of 2019. Currently, the interest rate futures markets reflect expectations for the U.S. Federal Reserve to cut rates more than once, and for a rate cut by the European Central Bank and Bank of Japan. But, these actions may not be enough to avert all the risks to growth.

It is important to remember that central bank rate cuts and other actions did not stop the most recent recessions in the U.S. in 2008, Europe in 2011, and Japan in 2014.

  • In the U.S., the first rate cut in September 2007 came just a few months before the economy peaked in December and entered a long recession. 
  • In Europe, the first rate cut in November 2011 took place just as the recession began that lingered until early 2013.
  • In Japan, with rates already near zero in late 2014, the Bank of Japan took action by increasing the pace of asset purchases just as GDP was reported to have contracted in the third quarter.

While some of these actions by central banks led to short-term rallies in stocks, none of them averted recessions. If the leading economic indicators continue to slide, it could mean an end to the global economic cycle despite the best efforts of central bankers.

Synchronized cycles

The global economic cycle is now 10 years old, it has been that long since countries amounting to more than 50% of the world’s GDP have been in recession at the same time. But, individually, not all of the world’s economies have experienced cycles that long; as noted in the section above, Europe and Japan have both experienced recessions at different times after the last U.S. recession ended in 2009. Despite their differences in timing, the economic cycles in Europe and Japan have been tracking the path of the longer U.S. expansion. For example, in terms of job growth, the Europe and Japan have been tracking the U.S. cycle, thus far.

Job growth tracking similar path: percentage growth in jobs from start of rebound

total employment change percent in US Japan and Eurozone

Source: Charles Schwab, Bloomberg data as of 6/16/2019.

In terms of GDP growth, Europe has been tracking the U.S. path from the start of the cycle, though Japan has been a bit slower.

GDP growth tracking similar path: percentage economic growth from start of rebound

total GDP change percent in US Japan and Eurozone

Source: Charles Schwab, Bloomberg data as of 6/16/2019.

Since the economic cycles among the world’s major economies have been synchronized for nearly five years now, the global leading indicators signaling a broad downturn are important to watch.

Being prepared

Many investors focus on the historically negative signal for the overall stock market indicated by a yield curve inversion, as inversions typically precede economic recessions. But, the opportunities signaled by a yield curve inversion deserve just as much attention. 

Inversions often mark a reversal in long-term market performance trends as leaders and laggards change places. For example, examining the relative performance of growth and value stocks we can see that reversals in long-term trends were often marked by inversions in the U.S. yield curve (for more about what yield curve inversions might mean for performance trends read Inversions and Reversals: Leaders and Laggards May Be Changing Places). This has also been the case for U.S. and international stocks.

The chart below depicts long-term relative performance around yield curve inversions for U.S. and international stocks. When the blue line is rising, international stocks (MSCI EAFE Index) are outperforming U.S. stocks. When the orange line is rising, U.S. stocks are outperforming international stocks. The shaded areas are periods when the U.S. yield curve was inverted.

Changes in U.S. and international performance trends around yield curve inversions

MSCI EAFE vs MSCI US

Shaded areas mark periods when the U.S. yield curve was inverted (3 month to 10 year)
Source: Charles Schwab, Factset data as of 6/16/2019.

The periods of inversion fell near the reversals in the longer-term trend of relative performance between U.S. and international stocks.

  • In 1989, the yield curve inversion came just as the long-term trend in relative outperformance by international stocks was ending and U.S. stocks were beginning a decade of dominance.
  • In 2000, the yield curve began to invert as the momentum was showing signs of shifting away from U.S. stocks toward international stocks.
  • In 2006-07, the yield curve inversion appeared to mark the reversal of the long-term trend of relative outperformance by international stocks compared to U.S. stocks, leading to outperformance by U.S. stocks since then. 

The yield curve has inverted again. Because of the track record of an inverted yield curve as a signal of a potential bear market and recession on the horizon, some investors are focused on preparing for a more difficult market environment. When markets get difficult, investors often instinctively seek to concentrate their portfolio on what had been leading and eliminate what had been lagging. That instinct might limit investors from seeing opportunity and the potential for a reversal in the leaders and laggards. It is possible the long-term trends in relative performance are again nearing a reversal, potentially signaling a shift to outperformance by international stocks.

Resisting the emotional response to difficult markets by maintaining exposure to the laggards through portfolio rebalancing may offer the opportunity to benefit from the potential for a reversal in relative performance trends in addition to greater diversification.

Diversification is back

Fortunately, the trend in the degree to which the world’s stock markets move in sync with each other has fallen to the lowest level in 20 years. Measured statistically, the broad trend in correlation between stock markets of the Group of 20 nations (plus Spain, which is a quasi-member), that together make up 80% of world GDP, peaked in 2011 and has since fallen to levels not seen in 20 years, as you can see in the chart below.

Broad trend in global stock market correlation slides to 20 year lows

Average correlation of G20 countries

Daily one-year rolling correlation of one month percent change in MSCI indexes for countries in G20 and Spain.
Source: Charles Schwab, Macrobond, MSCI data as of 6/16/2019.

This decline in correlation has taken place despite synchronized economic growth in these economies in recent years and growth in the trade among them. On the chart above, it almost appears to be a return to a “normal” correlation as the trend illustrated by the standard deviation has moved back to the average level that prevailed for more than 25 years through the 1970s, 1980s, and for much of the 1990s prior to the bubbles in tech and housing.

If sustained, this lower correlation—and the risk-reducing benefits of diversification it suggests as markets move more independently of each other—is particularly good news right now. It has the potential to offer globally diversified investors the benefit of less volatility without hampering returns on the path to financial goals—in essence decreasing risk without decreasing return.

Global diversification is something investors, no matter where they live, often fail to do. When investors talk about “the stock market” they are most often referring to an index that tracks stocks only in their home country. This “home bias” is evident when it comes to the make-up of investors’ stock portfolios as well. Investors tend to hold mostly domestic stocks—even when their country is the home of only a small portion of the world’s stock market, as you can see in the chart below.

Home bias: Investors’ portfolios often overweight their home country

Share of investment portfolio in domestic assets 

Share of investment portfolio in domestic assets

Source: Charles Schwab, International Monetary Fund Coordinated Portfolio Investment Survey, Factset, data as of 6/16/2019.
*countries with asterisk reflect 2017 data, others 2018.

The chart above shows that U.S.-based investors seem to believe they are sufficiently diversified with about 75% of their stock market investments inside their country’s borders, as do those that live in Japan or Greece or dozens of other countries—even Brazil and South Africa. A broader perspective may be helpful in managing the volatility that may lie ahead.

Takeaways

In the second half of 2019, stock markets around the world will likely have to contend with slowing global economic growth as leading indicators point to an increasingly vulnerable world economy that may be worsened by shocks from trade tariffs and other factors. The potential for reversals in long-term market performance trends may catch unprepared investors by surprise. Investors should ensure they have an appropriate amount of broad international exposure, including both emerging and developed markets, in their portfolios to potentially benefit from opportunities for performance and diversification.

What You Can Do Next

3 Retirement Income Mistakes to Avoid
After Hours Trading: Will It Work for You

Important Disclosures:

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market or economic conditions. Data contained herein from third party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.

Past performance is no guarantee of future results and the opinions presented cannot be viewed as an indicator of future performance.

International investments involve additional risks, which include differences in financial accounting standards, currency fluctuations, geopolitical risk, foreign taxes and regulations, and the potential for illiquid markets.  Investing in emerging markets may accentuate these risks.

The MSCI World Index captures large and mid-cap representation across 23 Developed Markets countries. With 1,654 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in each country.

The MSCI EAFE Index is an equity index which captures large and mid-cap representation across 21 Developed Markets countries around the world, excluding the US and Canada. With 924 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in each country.

The MSCI USA Index is designed to measure the performance of the large and mid-cap segments of the US market. With 641 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in the US.

©2019 Charles Schwab & Co., Inc. All rights reserved. Member SIPC.

(0619-9FBZ)

Thumbs up / down votes are submitted voluntarily by readers and are not meant to suggest the future performance or suitability of any account type, product or service for any particular reader and may not be representative of the experience of other readers. When displayed, thumbs up / down vote counts represent whether people found the content helpful or not helpful and are not intended as a testimonial. Any written feedback or comments collected on this page will not be published. Charles Schwab & Co., Inc. may in its sole discretion re-set the vote count to zero, remove votes appearing to be generated by robots or scripts, or remove the modules used to collect feedback and votes.