Please note the views expressed in this bulletin are those of the author and do not necessarily reflect AMP Capital’s house view.

Theme 1: What do the latest flash PMIs mean?

The June round of PMIs capped off a mixed picture for the first half of the year, but an acceleration in the second half of the year is still probable.

The June round of flash manufacturing PMIs presented a mixed picture, but there are a couple of trends which stand out. Europe is accelerating, the US is moving sideways (but still at a decent level), while Asia is bouncing around the 50 mark.

Europe and the US will likely be the main growth drivers thanks to a strong consumer in the US and significant positive tailwinds behind the Eurozone economy. Japan and China will rely on the US/EU for export demand, and policymakers at home for domestic growth. This is a fairly straightforward story and it will probably play out that way unless something somewhere blows up along the way. The other point to note is that a lot of economies tend to be seasonally stronger in the second half of the year, so it still seems sensible to expect improving global growth in the second half.

Theme in pictures





Source: AMP Capital, Bloomberg, Markit


Theme 2: The shipping slump

Global trade volumes collapsed in the first quarter, but are likely to recover in the second half of the year.

Continuing on the previous point, one of the features of the first half of the year has been the fall in global trade flows. It’s worth paying attention to trends in global trade as it reflects the state of the global economy and is a key driver for the more export oriented economies (such as China/Japan/Germany/Korea). Looking at the charts below it may seem like there is cause for concern, but given the seasonal patterns and the global growth dynamics mentioned above it makes sense to expect a concomitant improvement in global trade volumes into the second half of the year.

Theme in pictures

 





Source: AMP Capital, Thomson/Reuters Datastream, Bloomberg.


Theme 3: How profitable are emerging and developed market companies?

Emerging market equities have seen a notable decline in profitability, but this is unlikely to be permanent.

The profitability of emerging market and developed market companies has now gone beyond convergence to the point that emerging market return on equity has fallen below that of developed markets. With the benefit of hindsight, the economic drivers are clear with the structural challenges in emerging markets precipitating in lower growth outcomes. In addition, commodity prices have also slumped, which is a symptom for commodity consumers and a cause for commodity producers. As such, asset turnover and earnings margins have fallen (i.e. return on assets has collapsed from 4% in the mid-2000s to approximately 2%). The only thing slowing the decline in return on equity has been the rise in leverage (note that emerging market leverage is still considerably lower than developed markets). This isn’t necessarily the ‘new normal’ because emerging market countries still, on aggregate, have higher potential growth rates than that of developed markets. However, at this juncture, structural and cyclical headwinds have come to the fore.

Theme in pictures



Source: AMP Capital, Bloomberg


Theme 4: Inflation surprises

Inflation has generally been surprising to the downside around the world over the past couple of years.

The past couple of years have been a little unusual in terms of the way that inflation has consistently and considerably surprised to the downside. Looking at Citi’s inflation surprise indices (the inflation versions of the popular ‘economic surprise indices’), there has been a consistent pattern of downside surprises across regions and countries. The commodity price collapse clearly played a role in the more recent outcomes. It’s useful context for the succession of central bank easing measures around the world. It’s also notable because it’s unusual and it is one of those things that is mean reverting i.e. people are either going to change their expectations or inflation is going to increase. Expect the latter…

Theme in pictures



 Source: AMP Capital, Thomson/Reuters Datastream, Citi.


Theme 5: Is the deflation scare over?

Yes, the deflation scare is over!

I enjoyed updating my deflation proportion chart – this chart saw a lot of interest earlier in the year around the climax of the deflation scare. The most recent iteration (May) has seen a notable drop in the proportion of countries around the world that are seeing negative annual inflation rates. It’s important to note that this is headline inflation which, among other things, also reflects what’s going on in commodity prices. On that front there are some elements in place that would be conducive with a cyclical rebound in commodity prices. In addition, wages appear to be rising in both Europe and more notably in the US. I’m not a hyperinflation alarmist by any means, but it is reasonable to expect higher inflation from here – certainly the deflation scare is done with for now.

Theme in pictures

 


 
 Source: AMP Capital, Thomson/Reuters Datastream

About the Author

Callum Thomas, MMgt (finance), MMgt (banking), BBS (finance), Investment Strategist

Callum is an Investment Strategist in the strategy team of the Multi Asset Group at AMP Capital. Callum has a passion for global macro investment strategy and constantly strives to generate unique and innovative insights that help inform the strategy team's dynamic asset allocation process. Callum is responsible for researching a range of asset classes and global macroeconomic themes to aid in formulating investment strategies across the Multi-Asset Group. He also keenly collaborates with the global equity and fixed income teams. Callum originally joined AMP Capital in June 2009 as an analyst in the investment business of what was then AXA New Zealand. He previously worked in strategy at the New Zealand Stock Exchange.