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4 On the positive side, labor markets in most advanced economies are healthy and wages are rising. Furthermore, inflation isn't yet a problem, even in places where unemployment is low (like the United States, Germany and Japan) because the seemingly low supply of workers isn't translating into higher consumer price inflation (in economic language, the Phillips Curve is flat). On the negative side, global trade is stagnating and manufacturing growth is weak (Exhibit 4)—and it isn't just because of tariffs. The more important issue to us is that inventories in the manufacturing sector are too high relative to sales. As shown in Exhibit 5, inventories have generally been growing faster than sales since the financial crisis. This suggests that producers and wholesalers are overestimating end demand. During the China stimulus and Trump reflation cycle of 2017, inventories began to draw, but this trend reversed as the stimulus wore off and trade uncertainty began to disrupt supply chains. We don't think that the weakness in the manufacturing sector is enough to bring down the U.S. economy, but it is a strong headwind for investors. Both equity and fixed income markets, generally speaking, care a lot more about global manufacturing activity than consumer activity. Indeed, a simple correlation analysis shows that bond yields are much more linked to manufacturing trends than retail sales. There is essentially no relationship between U.S. bond yields and retail sales. Further, equity earnings revisions tend to move in tandem with manufacturing PMIs. The bottom line is that as long as global trade remains weak and manufacturing inventories remain elevated, global bond yields are likely to remain low (meaning sub-2% U.S. 10-year yield), and broad equity markets are likely to remain range-bound and choppy. 3 EXHIBIT 4: GLOBAL MANUFACTURING AS WEAK AS IT HAS BEEN SINCE THE FINANCIAL CRISIS JPMorgan Global Manufacturing PMI (diffusion index, 50+ = expansion) Source: J.P. Morgan, Markit. July 1, 2019. Past performance is not a guarantee of future results. EXHIBIT 5: GLOBAL INVENTORIES ELEVATED AS DEMAND REMAINS SLUGGISH Inventory to sales ratio, Indexed 2005 = 1 Source: OECD, WB. Data as of June 30, 2019. Series is a manufacturing value-added weighted aggregate of Germany, Japan and the United States. Past performance is not a guarantee of future results. 3 This is of course assuming that the Phillips Curve remains flat and inflation stays dormant (which is our base case for at least the next year). The trade war also acts as a hard ceiling for equity valuations.

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