However additional issues have cropped up over the holidays. Probably, the most worrying occurrance was the continued bullying by Trump of US Central Bank Chairman Jerome Powell. Reports that the President inquired about firing Powell is a disturbing sign for markets. This kind of behaviour is to be expected in some emerging markets but for this even to be discussed in the US is worrying.
The profit warning from Apple yesterday was taken badly by markets but more worrying was the eleven points drop in the ISM new orders component of the ISM manufacturing index. Since the mid 1960’s a decline of this magnitude has only happened twice outside of recessions.
On the other hand, there are some positives on the horizon. Valuations are now much more compelling. Peak forward earnings multiples reached 18.5 in 2018 in the US and this ratio now stands at 13.5. This is a drop in valuations of some 25% on this measure. According to JP Morgan, since 1920 there have been 20 episodes of PE multiple contractions of 20% or more. In 15 of those 20 episodes, US equity market returns were positive over the next 12 months with the average gain being an upside of 12%. It appears that the risks of a 30-50% equity market collapse, as seen in the 70’s and in 2008, are limited due to the much stronger US banking system, the decline in global current account imbalances and a world which is slowing, rather than heading into a recession.
However, this no recession view does require for policy makers to hit the pause button. The pause has to come about in two areas. First, the Fed has to hit the pause button on rate increases. It is notable that today’s rally has been spurred on by Powell announcing the Fed can change the policy on the balance-sheet run-off. Second, China and the US have to hit the pause button on a mutually destructive approach to trade. These are the two things market participants will be monitoring closely in the months ahead. It appears to be the case that recent market volatility makes better outcomes more urgent but also more plausible.