Markets are flashing red on growth as investors begin to return to pre-election bets on the “new normal”—a persistently weak economic expansion.
But there are signs that the sugar rush of Donald Trump’s victory and global-growth hopes has faded, raising doubts among some investors about whether stocks can stay high.
The sharp drop in government-bond yields is the most obvious signal that something is amiss. It is backed up by ominous signs from raw-materials markets, where copper and iron-ore prices have tumbled, and a swing in leadership of the stock market away from go-go bank shares and cheap “value” stocks to safety-first utilities, real estate and companies with high-quality balance sheets and reliable earnings. All this has come as inflation expectations priced into bonds have fallen and as some weak data has led to downgrades of economic forecasts.
Technology stocks’ return to favor also suggests investors are looking for companies able to deliver growth even if the economy is weak.
“The new normal’s still with us,” says Scott Minerd, chief investment officer of Guggenheim Partners. Investors, at least for a time, thought the promise of change that came with Mr. Trump’s election could help break the U.S. economy out of slow-growth mode, Mr. Minerd said. “So far, we’re long on promise and short on delivery. The market’s waking up to that.”
There are two big question marks around the market portents: Are they right? If so, do they spell doom for shares?
One way the omens could be wrong is if they are caused by something other than a slowdown. The most obvious candidate is geopolitics, with money seeking safe havens ahead of Sunday’s French election and amid the concern about North Korea’s nuclear threats. It is impossible to know how much this has depressed bond yields, but buying of bondlike utility and real-estate stocks might be a result of falling bond yields, rather than supporting evidence of a slowdown. Commodity prices need a separate explanation, but their fall might just be coincidence.
The market message could also be wrong if the economy is just fine. Evidence is gathering that the hoped-for rebound didn’t come through in the first quarter, with the Federal Reserve Bank of Atlanta’s “nowcast” of first-quarter growth down to just 0.5%, from above 3% in early February. Economic surprises—the degree to which reported data beat forecasts—are now barely positive, too, having dropped back from a three-year high in March, according to Citigroup.
But there is a long history of first-quarter data being wrong due to seasonal adjustment errors, and the “soft” survey data is still strong, if less so than it was.
The White House and Congress have failed so far to make progress on tax cuts or infrastructure spending, either of which could give the economy a boost. But Mr. Trump is nothing if not flexible, and a deal later this year is plausible.
Nick Gartside, international chief investment officer for fixed income at J.P. Morgan Asset Management, says there is contradiction between still-high stock prices and tumbling bond yields. But he expects it to be resolved by yields rising and the market again pricing in a faster pace of rate rises by the Federal Reserve, as it did earlier this year.
“It’s ludicrous that the Fed’s priced for only one more rate hike this year,” he said.
Sliding Treasury bond yields over the past month have pushed down mortgage rates, a boon for refinancing homeowners. The average rate for a 30-year fixed mortgage fell to 3.97% from 4.08% last week, Freddie Mac said Thursday, the first reading below 4% since mid-November.
The second question is trickier. The past five years have shown that high and rising share prices are compatible with weak economic growth, so long as yields stay low. Economically sensitive cyclical stocks might underperform— Ford , General Motors and Fiat Chrysler are all down close to 10% since bond yields began to fall in mid-March. But in an era of low bond yields, equities as a whole have been held up by the argument that there isn’t a better alternative for investors.
RECENT STREETWISE COLUMNS
Vincent Mortier, deputy chief investment officer at Amundi, Europe’s biggest asset manager, says lower bond yields “are saying to us we had better be more cautious on equities.” Investors have been buying the dips because U.S. profits haven’t been questioned, but he worries that any correction will be brutal. “It can be a big adjustment when people wake up,” Mr. Mortier said.
So long as low growth means low interest rates and doesn’t threaten profits, it’s fine for shareholders. But with the economy near full capacity, even tepid growth could be enough to push up wages and inflation, hurting profits and keeping the Fed on alert to raise rates.
Rising rates and weak growth are a terrible combination, so investors should take the warnings seriously, and hope that the signs are wrong.
Write to James Mackintosh at James.Mackintosh@wsj.com
Tags: commodity prices, Donald Trump, drop in government-bond yields, Federal Reserve, Fiat Chrysler, French election, General Motors, Gord, Guggenheim Partners, health care, healthcare, new normal of sluggish economy, North Korea's nuclear threats, Paul Ryan, persistently weak economic expansion, tax cuts, Technology stocks’ return to favor