For Public Distribution in the U.S. For Institutional, Professional, Qualified and/or Wholesale Investor Use Only in other Permitted Jurisdictions as
defined by local laws and regulations.

Principal Global Investors

Economic Insights: Headlines still
worried, momentum a little better
September 2019
Commentary by Robert F. Baur, Ph.D., executive director, chief global economist

The world economic slowdown refuses tofade. The frenzy of gloom about imminent
recession seemed to peak in August, butthere are still few clear signs of recovery.
On the edges, though, economic
momentum feels better. We look for a mild
rebound in global growth into mid-2020. If
it occurs, that should offer a modest upsideto the stock market.

Tug-of-war
For some months, the world economy has seemed
at a crossroads. With industrial activity stagnating,confidence downcast, trade tension lofty, profits flat, andstock markets under pressure, the gloomy stage feels set
for recession.
And yet. Pulling the economy back from the brink wererobust household spending, solid labor markets, healthy
wage growth, super-low long-term interest rates, andeasier central bank policy.
The global economy struggles to find a bottom to thislong-running slowdown.
That tug-of-war continues, and the geopolitical backdrop
remains ugly. But look closely. The data is more mixed
than headlines may indicate. There’s even evidence ofgreen shoots out there.
Look at China, for example. Headlines described therecent August data as disappointing, with key sectors
experiencing slower year-over-year growth than in July:• Retail sales: 7.5% versus 8.0%
• Industrial production: 4.4% versus 5.1%

These results belie the fact that there’s been monthly
sequential progress since the low earlier in the year.
The trough for China’s growth seemed to be the periodof February through May, with monthly data improving
in June and August. Industrial production had a nice0.4% or so bounce in August from July, even though
year-over-year growth fell. Fixed investment was also up
sequentially the last few months. Exports and imports
are both above a recent trough. Auto sales are down
sharply over last year but have advanced nicely the last
several months (incentives had boosted prior sales).
Railway traffic and electricity output are above their lowsfrom earlier in the year. Business surveys have tickedhigher with manufacturing now showing expansion.
Further, Chinese data on industrial profits, exports,
nominal gross domestic product (GDP), producer prices,
crude steel, and cement output, among other series,
haven’t declined as severely as those of the industrial
recession of 2015. That’s also true of private surveys of
United States company sales to China.
We look for official growth data in China to stabilize
close to the 6% range this year.
The Eurozone is a slightly different story. Preliminary
results of September business surveys were well below
expectations. Manufacturing business gauges hit thelowest since the Euro-area debt crisis of 2012—weighed
down heavily by the German result, which was lower
than during the global financial crisis. The tally of service
businesses also fell but remained solid and above
January’s low.
The Eurozone Commission survey on economic
confidence fell again, but showed the dispersion between
industry and households, as consumer confidence stayedat mostly healthy levels. Though down sharply over theprior year, Eurozone auto sales are recovering nicely fromlast year’s big change in emission standards.

• Fixed investment 5.5% versus 5.8%
Expressions of opinions and predictions are accurate as of the date of this communication and are subject to change without notice.
There is no assurance that such events or prospections will occur and actual condition may be significantly different than that shown here.

For Public Distribution in the U.S. For Institutional, Professional, Qualified and/or Wholesale Investor Use Only in other Permitted Jurisdictions as
defined by local laws and regulations.

Germany is the downside outlier, likely already in a mild
recession. German manufacturing exports were hit hardby the slowdown in China and rising labor costs are
squeezing profits. France is expanding, buoyed by risingbusiness and consumer confidence, the prospect of new
tax cuts, and some structural reforms, which improved
competitiveness.
Overall, Euro-area bank loans and the money supply arerising, job growth is still okay, and households appear
resilient. Falling business surveys suggest growth may
stay near 0.5% or so, with some downside risk.
The Japanese economy surprised positively in thefirst half, but, like the Eurozone, is being worn downby the global slump. The two-percentage point hikein the Value-Added Tax, set to take effect next week,
will further drag an already weak story. The Markit
News survey of manufacturing businesses fell back to
its January low, but the tally of companies in service
businesses was the second highest since 2017. Like otherdeveloped countries, tough and hardy households arecarrying Japan’s economy.
There are still plenty of local recessionistas, but the
U.S. may be the closest to a clear recovery from theworld economic stumble of the last 20 months. Housing
activity is visibly accelerating with sales, starts, pending
sales, and homebuilder confidence all in distinct
uptrends. That doesn’t happen with a recession lurking.
Industrial production is getting a nice bounce after
languishing most of the year. The Markit News canvassesof manufacturing and service businesses both tickedhigher. Household confidence is off the peak butvery strong. Job openings are a bit below last year’s
November high. There are no signs of layoffs, andconsumers still see a welcoming job market with many
employment opportunities.
We look for the U.S. economy to track 2% to 2.5%
growth well through most of 2020.

Downside risks
They’re weighty. Geopolitical risks are large and wellknown. But the biggest recession risk we see is adeterioration in corporate profits. Business sentimenthas been lousy all year. The portion of chief executives orfinancial officers who expect a recession in the next year
has stayed above 60% since January. Capital spending
has been weak. Hiring has slowed.

that margins have been shrinking. Business sentiment isclosely tied to profit growth. Overall profits have beenmostly flat for several quarters and are below their 2018
peak. Rising labor costs and higher interest expense fromgreater debt burdens have pulled earnings lower.
Improving productivity can arrest some of the marginpressure and has been helping for a couple years.
However, accelerating wage growth in this late stage ofthe business cycle will be a persistent problem.
Besides slowing job growth and an inverted yield curve,
dwindling profit margins are a third clear sign of a U.S.
recession somewhere out in the future.

Connecting profits, trade
There’s another reason to be uneasy about profits.
Today’s trade conflicts are a symptom of an upheaval in
the underlying world economic framework. U.S. profit
margins have been surging since the 1990s, partly
from globalization. When China joined the World Trade
Organization in 2001, the country added hundreds ofmillions of low-cost workers to the world labor supply.
U.S. companies moved production facilities to utilize
those workers and export their lower-cost goods to theWest. Those competitive wages in China led to weaker
demand for labor and slower wage gains in developed
countries. In the U.S., labor’s share of the total output
value of all goods and services produced plunged. The
remaining portion of output value accrued to capital or
business profits, which surged.
Every cycle produces within it the seeds of its own
destruction. This one is reversing for two reasons.
Chinese wages grew very fast as more global companies
set up shop there. Chinese workers gradually becameless competitive. Then slow wage growth and the
popular narrative of stagnant income created a politicalbacklash that’s still playing out in the U.S. and greater
Europe. Today’s trade tensions are a consequence of thatbacklash.
For both reasons, businesses are reworking their supply
chains. These changes will likely result in higher laborcosts as developed-country workers regain a measureof bargaining power. That will dent those lofty profit
margins.
In fact, the workers’ share of output value has already
reversed some of the fall of recent decades. And themirror image is narrowing margins and shrinking profits.

For some time, we chalked all that up to trade tensions,tariffs, and related uncertainties. However, recent
downward revisions to U.S. corporate profits suggest

Expressions of opinions and predictions are accurate as of the date of this communication and are subject to change without notice.
There is no assurance that such events or prospections will occur and actual condition may be significantly different than that shown here.

For Public Distribution in the U.S. For Institutional, Professional, Qualified and/or Wholesale Investor Use Only in other Permitted Jurisdictions as
defined by local laws and regulations.

Looking ahead
While growth is struggling in the Eurozone and Japan, we
expect the developing momentum in China and the U.S.
to broaden into a modest world upturn into 2020. With
companies under profit pressure and uncertainty still high,any revival that gets underway could run out of steam latenext year or early in 2021. That might set the stage for amild recession.
The long rise in corporate debt, propelled by super-low
interest rates, could bring credit strains and worsen a
nascent downturn. For now, though, let’s enjoy therecovery and see what happens.

Investment ideas
What does this framework mean for interest rates? Itsuggests that the plunge in government bond yields
this year overestimated the risk of imminent recession indeveloped countries, especially in the U.S. So yields on
10-year U.S. treasury bonds surely found a trough at 1.4%.
Better growth should put upward pressure on yields.
However, the Eurozone economy is lethargic, and theEuropean Central Bank will keep monetary policy extraaccommodative for the foreseeable future. Accordingly,
yields on 10-year German bunds will stay well below zero.
That crazy-low level will likely keep U.S. treasury bondyields from rising above 2%. If yields did hit 2% or more,
U.S. treasury bonds would be worth a buy for a shortterm trade.
Since clear evidence of a U.S. growth renewal may comeonly grudgingly, the Fed will likely cut the fed funds rate
another 0.25% in October. If that occurs, we’d expect nofurther Fed action for a long time.
Another reason for a lengthy hold is the current Fed
debate on instituting a strategy to “make up” fordeviations of inflation below 2%. The target would be
2% average inflation (allow inflation above target tooffset time below target). Either way, the Fed will likely
remain on hold until the next recession.
With this backdrop, we’d suggest bond investors stickto high-quality corporate bonds. Corporate leverage has
increased dramatically, and credit stress will rise sharply
ahead of the next recession, so good quality and robustinterest coverage are essential. One could mingle insome of the most liquid, best quality bonds in the highyield or emerging market universe to reach for a little
better yield. Except for a trade as noted, we’d avoid
government bonds until well into 2020. Euro-area
corporate bonds, too. We doubt their current highvalues are indicative of any fundamental worth; inshort, they’re overpriced.

What about equities? Even though U.S. stocks are nearrecord highs, they’ve been in a slow-motion bear market
since January 2018. Even today, the S&P 500 Index is only
3% or so above that level. That was also the month of peakvaluations; today’s price-earnings ratios are well below thoseof early last year. Big tech stocks, epitomized by the FAANGs,
have been the leaders of the long rally from March 2009.
But their outperformance ended in June of last year. Passive
investors cannot be happy.
Outside the U.S., broad indices are not near prior highs. The
STOXX Europe 600 Index is still more than 5% below its highof April 2015. The Nikkei 225 in Japan would have to riseover 10% to reach its October high of last year. The broad
MSCI index of emerging market stocks remains more than
20% beneath the top of January 2018.
What’s happening is that low interest rates have reachedthe limits of their ability to drive stock markets higher, absent
surging economic growth. Similarly, easier monetary policy
can no longer be counted on to lift stock prices much more.
After all, how could central banks be any more dovish thanthey are right now? Yet stocks are going nowhere.
Consider that the huge fourfold rally in U.S. stocks inthe decade after March 2009 coincided with the slowest
recovery from a recession in U.S. history, thanks to interest
rates. Today’s stock price is thought to reflect the present
value of future earnings or dividends. As interest rates fall,
the present value rises even if future earnings don’t change.
To rally further, stock prices need better economic growth.
Hopefully, that’s coming.
October could be an erratic month; it has been historically.
If world growth does pick up mildly into next year as we
expect, stock prices should have at least some modest
upside. There could be new highs for the S&P 500 Index anda return to (or near) past highs for other broad indices. With
recession prowling somewhere out in the future, one should
stay cautious as stocks still sport elevated valuations.
That said, we’d prefer U.S. large-cap stocks to other indices,even as international stocks are more cheaply valued. Smallcap stocks usually underperform in the later stages of thebusiness cycle.
We’d also maintain a portfolio balanced between
defensive and cyclical sectors. Dividend-paying stocks
and bond proxies have gotten very expensive and techstocks are well past their performance peak. There was a
short rotation into value stocks in early September, but it
didn’t last. Longer-term, that rotation will persist, but notin the next several months.
Stay balanced. Stay cautious.

Expressions of opinions and predictions are accurate as of the date of this communication and are subject to change without notice.
There is no assurance that such events or prospections will occur and actual condition may be significantly different than that shown here.

Disclosures
Unless otherwise noted, the information in this document has been derived from sources believed to be accurate as of April 2017.
Information derived from sources other than Principal Global Investors or its affiliates is believed to be reliable; however, we do
not independently verify or guarantee its accuracy or validity. Past performance is not necessarily indicative or a guarantee of
future performance and should not be relied upon to make an investment decision.
The information in this document contains general information only on investment matters. It does not take account of any
investor’s investment objectives, particular needs or financial situation and should not be construed as specific investment advice,an opinion or recommendation or be relied on in any way as a guarantee, promise, forecast or prediction of future events
regarding a particular investment or the markets in general. All expressions of opinion and predictions in this document are
subject to change without notice. Any reference to a specific investment or security does not constitute a recommendation tobuy, sell, or hold such investment or security, nor an indication that Principal Global Investors or its affiliates has recommended a
specific security for any client account.
Principal Financial Group, Inc., Its affiliates, and its officers, directors, employees, agents, disclaim any express or implied
warranty of reliability or accuracy (including by reason of negligence) arising out of any for error or omission in this document orin the information or data provided in this document.
Any representations, example, or data not specifically attributed to a third party herein, has been calculated by, and can be
attributed to Principal Global Investors. Principal Global Investors disclaims any and all express or implied warranties of reliabilityor accuracy arising out of any for error or omission attributable to any third party representation, example, or data provided
herein.
All figures shown in this document are in U.S. dollars unless otherwise noted.
This document is issued in:Japan by Principal Global Investors (Japan) Ltd. (Kanto Local Finance Bureau (Kinsho) No. 462,
Japan Investment Advisers Association,
The Investment Trusts Association, Japan
This material is not intended for distribution to, or use by any person or entity in any jurisdiction or country where such
distribution or use would be contrary to local law or regulation.
©2017 Principal Financial Services, Inc. Principal, Principal and the symbol design and Principal Financial Group are trademarks
and service marks of Principal Financial Services, Inc., a member of the Principal Financial Group. Principal Global Investors is theasset management arm of the Principal Financial GroupDisclosures
本書は情報の提供のみを目的として作成されたものです。本書中の情報は、弊社及びプリンシパル・
ファイナンシャル・グループの関連会社において信頼できると考える情報源に基づいて作成していますが、適用法令にて規定されるものを除き、本書中の情報・意見等の公正性、正確性、妥当性、完全性等を保証するものではありません。本書中の分析、意見等はその前提が変更された場合には、変更が必要となる性質を含んでいます。本書中の情報は、弊社の文書による事前の同意が無い限り、その全部又は一部をコピーすることや配布することは出来ません。
また、本書中の情報はあくまでも投資に関する一般的なものであり、投資に関する完全な情報が記載されているものとして依拠されるべきではありません。 本書中の情報は貴社の投資目的、特定な
ニーズ、または財政状況を考慮したものではありません。投資判断をする前には、その投資がお客様の投資目的、特定なニーズ、および財政状態にとって適切であるかをご検討ください。
記載の内容は過去の実績値であり、将来を約束するものではありません。

プリンシパル・グローバル・インベスターズ株式会社
住所：〒100­0011 東京都千代田区内幸町1­1­1 帝国ホテルタワー１1階
電話：03­3519­7880（代表） ファックス：03­3519­6410
代表者：代表取締役社長 板垣 均
ホームページ：http://www.principalglobal.jp
金融商品取引業者登録番号：関東財務局長（金商）第462号
加入協会：一般社団法人 日本投資顧問業協会
一般社団法人投資信託協会

マーケットレポート：
977550