mid year outlook

By Jeffrey Kleintop, Charles Schwab

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.

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. 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.

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.

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.

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.

CFOs see a recession in 2020

The June 2019 survey of Chief Financial Officers shows that most CFOs expect a recession in 2020. 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.

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.

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.

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.

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. This has also been the case for U.S. and international stocks.

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.

This decline in correlation has taken place despite synchronized economic growth in these economies in recent years and growth in the trade among them. 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.

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.


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.


About LRPC’s Monday Morning Minute

Lawton Retirement Plan Consultants, LLC (LRPC) Monday Morning Minute is crafted to provide decision-makers with important information about the economy, investments and corporate retirement plans in a format that allows a reader to consume the information in less than 60 seconds. As an independent, objective investment adviser, LRPC has access to many sources of research and shares the best and most relevant information with its readers each week.

About Lawton Retirement Plan Consultants, LLC

Lawton Retirement Plan Consultants, LLC (LRPC) is a Milwaukee, Wisconsin-based independent, objective Registered Investment Adviser (RIA) providing investment advisory, fiduciary compliance, employee education, provider management and plan design services to employer retirement plan sponsors. The firm specializes in Socially Responsible Investment (SRI) strategies for retirement plans and is a pioneer in the field. LRPC currently has contracts in place to provide consulting services on nearly a half billion dollars in plan assets. For more information, please contact Robert C. Lawton at (414) 828-4015 or bob@lawtonrpc.com or visit the firm’s website at https://www.lawtonrpc.com. Lawton Retirement Plan Consultants, LLC is a Wisconsin Registered Investment Adviser.

Important Disclosures

This information was developed as a general guide to educate plan sponsors and is not intended as authoritative guidance, tax, legal or investment advice. Each plan has unique requirements and you should consult your attorney or tax adviser for guidance on your specific situation. In no way does Lawton Retirement Plan Consultants, LLC assure that, by using the information provided, a plan sponsor will be in compliance with ERISA regulations. Investors should carefully consider investment objectives, risks, charges, and expenses. The statements in this publication are the opinions and beliefs of the commentator expressed when the commentary was made and are not intended to represent that person’s opinions and beliefs at any other time. The commentary does not necessarily reflect the opinion of Lawton Retirement Plan Consultants, LLC and should not be construed as recommendations or investment advice. Lawton Retirement Plan Consultants, LLC offers no tax, legal or accounting advice and any advice contained herein is not specific to any individual, entity or retirement plan, but rather general in nature and, therefore, should not be relied upon for specific investment situations. Lawton Retirement Plan Consultants, LLC is a Wisconsin Registered Investment Adviser and accepts clients outside of Wisconsin based upon applicable state registration regulations and the “de minimus” exception.