The data you shouldn’t forget as global events rattle markets

It’s been a rough start to the year for markets, with events like the Coronavirus and bushfires in Australia rattling confidence and productivity.

However, it’s worth taking a step back from the noise to check in on some other data which informs outlooks for the year ahead.

As we have outlined in previous notes, despite the severity of events that are dominating headlines, there are a range of factors to consider when making projections for 2020.

Competing dynamics impacting global growth

A number of factors for the world economy from 2019 will carry over into this year. For example, debt levels are still high, inequality continues to rise, and electorates remain susceptible to the temptation of populist politics.

On the other hand, 2019 was characterised by effective monetary interventions from a number of central banks, and the stimulus of these programs will continue to be felt through 2019. The low interest rate environment is also buoying share markets, which tend to trade on higher price-to-earnings (P/E) ratios when interest rates and inflation are low. This relationship goes a long way to explaining the resilience of share markets since the global financial crisis, through a time of often patchy global growth and uncertainty, and the effect will continue into next year. Other non-cyclical megatrends that will continue to drive growth include technological innovation and the continued expansion of the Asian middle class.

Signs of improvement

A look at global business conditions (using purchasing managers indices (PMI) as proxy) shows that we are experiencing a downturn, however the pattern appears to be similar to the slowdowns of 2012 and 2016 rather than the global financial crisis. If that is indeed the case, we should see conditions improve in 2020.

There are a number of indications that this will eventuate. The US economy is booming, with unemployment at its lowest level since 1969¹ but wages growth inflation hasn’t yet risen to match, giving the Federal Reserve breathing space to maintain an environment of low rates and quantitative easing (QE). US Business and consumer confidence remain high, even if the former has slipped slightly over the past 12 months.

Market corrections of 10-20% in a year are common, and more often than not don’t indicate more significant falls to come. Even as the US yield curve temporarily inverted in August, other indicators pointed against recession, and the situation has continued to strengthen since that time.

How will this play out globally?

US trade policy continues to be the key risk, and ironically it is US companies that are suffering most. The vast majority of large US businesses operate with globally integrated supply chains, and as a result of Donald Trump’s trade barriers are forced to pay more for inputs than their overseas competitors, making their products less competitive and affecting business investment planning.

That said, we should expect Trump to be very responsive to economic concerns heading into an election year, and in that context an easing in his stance on trade (or at least no significant escalation) is likely. No US President has been re-elected where a recession has occurred in the final two years of their first term since Calvin Coolidge in 1924, and the strength of the economy will be front of mind for the President and his advisors heading into 2020.

Though Brexit has now occurred, the terms of the trade deal remain somewhat unknown. However, the prospect of a ‘no deal’ Brexit has receded on the back of a strong showing by the Conservatives in December’s General Election and the loss of influence of Northern Ireland’s Democratic Unionist Party in the new parliament. The prospect of “exit contagion” spreading to other countries in the eurozone has not eventuated, and the effect on trade to the EU as a whole will be far less than for Britain; 46% of UK exports currently go to the EU as opposed to 6% in the other direction².

China’s outlook is of course a critical consideration, and the Coronavirus is currently front of mind in that respect. You can read our latest view on this unfolding situation here, including its impact on markets.

All things considered, there are strong signs that these factors will lead to an upswing in global economic growth in 2020. As mentioned, PMIs indicate that business outlook is stabilising, bond yields have fallen again and the effect of monetary stimulus programs will continue. Manufacturing inventories have also been run down and won’t act as a drag on global growth as demand increases. Share markets are showing strength inside and outside the US, and the outlook for cyclical stocks also appears promising.
 

¹ https://www.washingtonpost.com/business/2019/05/03/us-economy-added-jobs-april-unemployment-fell-percent-lowest-since/
² https://www.bbc.com/news/business-46612362