Change is Imminent, Asset Allocation is Important

It has been my view until the recent past that a U.S. recession was not likely to occur within the next year but economic data as of late has led me to reconsider this opinion.

The institute of Supply Management (ISM) Non-Manufacturing PMI for July dropped from an expected 55.5 to 53.7; I recognize that a reading greater than 50 indicates expansion but this is the lowest reading we have seen since August 2016 *. Our economy is driven by the service industry and consumption, both of which show signs of slowing. Added to this, the last two Non-Farm Payroll releases from the Department of Labor have revised their previous readings lower** which is not comforting and is a trend we would prefer not to see.

The recent data points suggesting a rate of growth that is slowing are a reminder that it is all but impossible to de-couple the U.S. economy from that of the rest of the world. China is slowing***, Europe is slowing and now, seemingly, this is having a negative effect on the U.S. economy. Just this week Germany, the world’s 3rd largest economy, released their Industrial Production numbers for June which showed a fall of -1.5% MoM****, a sharper drop than market analyst expected. For an economy that is reliant upon exports of manufactured goods this is particularly disappointing news. Earlier today the U.K. announced that Q2 GDP dropped -0.2% (i.e. the economy contracted) which, given the Brexit difficulties, is bad news too*****.

What I am about to discuss might, at the outset, seem contradictory given what I suggested above but in an inter- connected world (geographically and financially) it is not: the need for Dollars is likely to pick up across the globe as people look for safe havens. Today the U.S. $ is still the world’s reserve currency (that is likely to change in the decades to come) and that coupled with the fact that the U.S. economy is seemingly stronger than that of other developed economies will cause investors to look to buy dollars and dollar assets such as Treasuries. Therefore, we have seen the 10-year Treasury yield drop sharply over the last week, given the global trend of lower and negative (Switzerland, Japan, Germany etc.) interest rates, it would not surprise us at all to see U.S. yields fall over the months to come.

Lastly, I’d remind you to be cognisant of the advantages of thought out and active asset allocation. We are partial to U.S. fixed income right now (where on the curve and which bonds depends on individual circumstance) and we will look to the more defensive sectors within equities such as utilities, consumer staples, healthcare and REITs.

As is always the case, please do not hesitate to reach out to your advisor for clarification or direction as required.

David Crook

Global Economist/Chief Strategy Officer

* www.instituteforsupplymanagement.org/ISMReport/NonMfgROB.cfm?SSO=1

** https://www.bloomberg.com/news/articles/2019-08-02/u-s-employers-added-164-000-jobs-in-july-as-wages-picked-up *** https://www.forexfactory.com/news/932624-china-lowest-gdp-growth-on-record-for-q2

**** https://www.forexfactory.com/#detail=106403

***** https://www.reuters.com/article/uk-britain-eu/brexit-hazard-warning-lights-uk-economy-contracts-for-first-time-since-2012- idUSKCN1UZ107

Thornton Kennedy