Some signals of global business conditions have deteriorated since early 2018, particularly in the Euro area. But, it is too early to panic about a downturn in the global economy.
Global trade volumes are still strong, the global consumer remains in good shape, business investment is rising and the upturn in the US economy will be an important driver for world growth in 2018 and 2019. Global growth will still remain above average in 2018 and 2019 at around 3.9% - the strongest pace since 2011.
Global trade issues are a risk for growth but current proposals for import tariffs between the US and China on their own are not enough to derail the growth upturn.
- Strong global growth and an uplift in corporate earnings remains a positive environment for equity markets. Investors should watch for a peak in global growth around early 2019.
Global growth expectations started off 2018 extremely positively, after a strong second half finish to 2017 thanks to booming momentum in business conditions and global trade. But, global data has disappointed expectations over the past few months and has raised concerns around the durability of the global growth upswing. Does the weakening in global data mean that the synchronised global recovery has stalled? Should we fear the beginning of a downturn? We explore these issues in this Econosights.
What does the latest data tell us?
A large part of the concern around growth prospects has been centred around a weakening in manufacturing PMIs (Purchasing Manager’s Indices). These indices are constructed by surveying purchasing managers at large global companies on various indicators such as orders, employment levels, inventories and prices paid. These surveys are generally considered to be forward-looking measures of economic conditions and growth. The consistent measurement of PMIs across the global economy also means easy comparison between countries.
The latest bout of weakness in manufacturing conditions has mainly occurred in the developed economies (see chart below). Emerging markets have held up better so far in 2018, albeit from lower levels.
Source: Bloomberg, AMP Capital
The strength in manufacturing PMIs in late 2017 was a reflection of exceptional short-term strength in the global economy which was unsustainable. So, the weakening in these indicators over early 2018 is not a signal of the start of a deteriorating growth environment. PMIs are still running at levels that are associated with above-average global growth in 2018. And other indicators of global activity remain solid. Global trade volumes, for example, are still strong (see chart below).
Source: Reuters, Bloomberg, AMP Capital
The fall in PMIs so far in 2018 has been particularly pronounced in the Eurozone (which is also where a lot of the unexpected strength in PMIs occurred in the second half of 2017). PMIs are still holding up in the US and China (see chart below). Service conditions according to PMI surveys have also weakened globally, but not to the same extent as manufacturing indicators.
Source: Bloomberg, AMP Capital
The weakening in European PMIs is also reflected in a slowing across other Euro indicators over 2018 (e.g. industrial production, construction output, sentiment and retail sales). The Euro currency has been appreciating over the past which has been acting as a drag on exporters growth, particularly in Germany. More recently, the Euro has started to trend down which will provide some relief for exporters. A colder-than-usual winter has also been negatively affecting growth through limiting households’ ability to work and disrupting supply chains. We still expect Eurozone growth to be over 2% in 2018, much stronger than recent years (which have averaged at around 1% annually).
Despite softer business conditions lately, the global consumer is still holding up, especially in the US and China. Retail sales growth across both regions remains solid which reflects good conditions in the labour market (particularly in the US). Wages growth is gaining strength in the US, but still has room to increase as the unemployment rate declines further. Global readings of consumer confidence are still trending higher while business confidence has been weakening. We think the stumble in business confidence is a reflection of negative sentiment around global trade risks.
Business investment has been creeping higher in the advanced economies as growth has improved (see chart below), after years of weakness (a lot of this reflects a slump in oil-related capital expenditure). But, capital expenditure still has room to rise further as business investment has been declining as a share of growth across numerous advanced economies, leading to a decline in the capital stock and productivity growth. Stronger investment growth will be positive for commodity demand and price growth, with recent gains in commodity prices a sign of solid global demand.
Source: ABS, BEA, Reuters, AMP Capital
The fiscal spending boost to the US in 2018/2019 means that the US economy will make a larger-than-usual contribution to global growth over the next two years which will provide support to the global economy. While the risks around a trade war between the US and China have lifted over recent months and will pop up gain in May as the US makes a decision about tariffs on Chinese imports, the broad US fiscal spending that will occur over the next few years will be more than enough to the negatives from trade (see chart below).
Source: Strategas research, AMP Capital
There are also signs that Chinese growth will be better than expected over the next six months. Data around growth and investment is still running strong and there are signs that policymakers are willing to boost short-term domestic demand. This follows on from recent cuts to the reserve requirement ratio, which was done to provide some easing of liquidity pressures and as a support to deposit growth. Stronger Chinese growth in the near term may offset some of the weakness in the Eurozone and provide good support for commodities. The longer-term picture around China is still around slower growth, with a focus on deleveraging state-owned enterprises.
The latest from the IMF
The latest world economic outlook from the International Monetary Fund (IMF) still had a very positive tone, particularly for the advanced economies. The world economy is expected to grow above average in 2018 and 2019 at 3.9%. Despite the rosy near-term outlook, the IMF was quick to warn that these good conditions will be temporary so there is a need for countries to take current opportunities to strengthen their economies through reforms such as boosting infrastructure spending and strengthening government budgets.
Implications for investors
The peak in global growth is expected to occur around early 2019, as Chinese growth slows and the fiscal stimulus in the US economy wanes and interest rate rises from the Federal Reserve slow growth. The worsening debt picture in the US from higher fiscal spending is also a risk for the economy in 2019.
The weakening in some global growth indicators has not been broad based and the outlook for global growth remains very positive which is good news for corporate earnings. The current growth environment remains supportive of growth assets and share markets will continue to perform well while corporate earnings growth is rising, even whilst bond yields have been lifting. Higher bond yields are a sign of rising inflation expectations and strong global growth.
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