06 Dec 2019
Investors today are faced with the prospect of lower global growth rates for potentially longer periods of time, but what do we mean by lower growth and does it imply that we are recession bound?
A slowdown in economic growth in the order of 0.5%-1% from the headline rate causes little concern when growth rates are at the 3-4% level, but becomes scary when growth is hovering around the 1-2% level at best in major economies. A fluctuation in growth rates alone doesn't mean that a recession is imminent though. Historically, recessions have come from three causes, with the first being a policy mistake from central banks, typically the Fed, through over-tightening monetary policy. This was a concern for markets in 2018, but seems highly unlikely in the present climate. The second major cause of recession has been a spike in the oil price, which again looks unlikely in the short term, with oil price weakness resuming, despite the Iranian attack on Saudi oil fields. The third and perhaps more likely cause of recession in today’s world is an implosion of a major asset price bubble, but it's hard to argue that any asset classes are in bubble territory in today’s market, with the possible exception of government bonds. Private equity valuations may be vulnerable, but these have not been bank-financed.
Much of the slowdown this year has been caused by geopolitical uncertainty, which has impacted firstly on corporate capex, and now to an increasing degree on consumer confidence. The ongoing US China trade war has not only reduced capex in China, but has made multi-nationals unsure which country might be the next target of the US President. The complexity of setting up a manufacturing base reliant on global supply chains in a world where the rules-based system seems to be breaking down, has resulted in many multi-nationals adopting a wait and see attitude.
Trade uncertainty is also a factor within Asia as South Korea has its own dispute with Japan. In Europe as a whole, uncertainty over the level or extent of tariffs in a post-Brexit world is also taking its toll. In the UK, consumer confidence and retail sales have seen a significant downturn in the last three months, as has the construction sector. India had been a beacon of hope for growth, but in the last few months there has been a realisation that economic growth is not all that it appears to be and that economic data in India has been no more reliable than the numbers published by China. Combine this with a credit crunch emanating from the non-bank financial sector and you have a significant slowdown in loan growth in the Indian economy, with knock-on effects in the consumer space. Indian consumer goods companies, many of which are listed subsidiaries of multi-nationals, have reported a slowdown in sales growth to the mid-single digits. The Indian economy is considered to have excellent long-term secular growth drivers but an inflation rate of around 3% denotes a very significant slowdown.
Today’s level of low bond yields is a result of further economic weakness and there are concerns that the Lawrence Summers theory of secular stagnation will continue to dominate the global economy over the next decade. It is also a result of uncertainty over Trade Wars and Brexit, both of which can be resolved and could prove to be transitory. The market finds it hard to model for trade disputes and geopolitical uncertainty, which has impacted on corporates, with business capex pulled back as confidence has weakened. For now, corporates are not sure where to move to, even if they recognise that their imports from China will be subject to tariffs over the medium term. It is unclear whether other places with cheap labour, such as Mexico and Vietnam, will also be threatened by the United States. Trade tariffs against China is an area of politics in the States with cross-party unity and a tougher line on China looks likely to prevail for a number of years.
On the positive side, financial conditions in the global markets are now being eased across most countries. The US has reversed course from 18 months ago and Europe has changed tack under Draghi, with expectations of positive interest rates now pushed many years into the future. If China does slow further, there is still scope for additional fiscal stimulus.
Consensus forecasts for GDP growth in 2019 have been pulled back, but the global economy remains in an expansionary phase, albeit a slower one. Investors are focused on the prospects for 2020 and the fact that much of the current slowdown has been self-inflicted, potentially gives scope for a re-bound next year. Central bank policy will be easier in 2020 than it has been in 2019 and there remains the potential for increased fiscal stimulus from governments around the world. Whilst economic fundamentals have deteriorated, they are not yet flashing red and with inflation under control, more stimulus can be applied to the global economy. Another positive for the consumer is that to date, employment levels have remained strong and whilst wage growth is muted, it is generally above levels of inflation, so real disposable income amongst consumers when combining jobs growth with wage growth remains positive.
Graham O'Neill, Senior Investment Consultant, RSMR
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