Paul Niven discusses the state of the world economy and assesses the prospects for markets from here.
Following the significant correction in the final quarter of 2018, the first three months of this year saw broad-based positive returns for almost all asset classes, led by equities. Despite the strong rebound, concerns over the maturity of the cycle and the extended nature of the bull market remain – although fears of an imminent recession have receded, despite a brief inversion of the yield curve. The question remains how far market momentum can run, especially as global growth is tepid and recent data remains mixed. While we expect volatility to persist in the coming quarters, there are encouraging signs that suggest a modest upturn in growth is likely in coming months.
The US economy to remain on track in 2019
The outperformance of the US economy and stock market has been a dominant theme in recent years, but recent data has been mixed. Consumer spending and confidence is high, and the labour market continues to tighten, although the question of how long unemployment can continue to fall remains in focus. Wages are gently accelerating but this has yet to feed through into consumer prices. Mirroring the global picture, US manufacturing continues to be weak, but recent data on inventories and existing home sales has bettered expectations. The US political divide is greater than ever as January saw the longest government shutdown ever over an impasse between Trump and Democrats on funding for his border wall, a key campaign pledge.
Despite recent fears, we do not envisage a marked slowdown in the US this year. However, an inversion of the US yield curve should not be ignored and does raise some risks on the US economic outlook for 2020 and beyond.
While we expect volatility to persist in the coming quarters, there are encouraging signs that suggest a modest upturn in growth is likely in coming months
Europe and China – signs of stabilisation
Slowing growth in China has been impacting on markets around the world. The recent defensive fiscal stimulus implemented by the Chinese authorities, albeit less drastic than that used a few years ago, seems to have had a stabilising effect as March manufacturing data surprised to the upside. This pickup will positively impact sentiment and should feed through to other markets.
A slowdown in manufacturing has been contributing to the global slowdown, with eurozone manufacturing in recession, led by extremely weak data out of Germany. Despite this, there are signs that global manufacturing PMIs could stabilise over coming quarters as the correction to the 2017 manufacturing overshoot is complete and drags from an inventory cycle adjustment are receding. In fact, with the news flow turning up in China and Europe there is likely to be a gradual recovery in global growth in 2019.
Looking at Europe more generally, whilst manufacturing has been a significant drag, services are showing a decoupling with the services PMI proving very resilient. Service confidence data also paints a rosier picture, indicating that domestic demand is in fact fairly strong in the face of external risks. General sentiment data indicates consumption growth will pick up soon, especially as a tight labour market ultimately leads to upwards wage pressure and inflation remains low. Industrial production is beginning to improve as stronger headlines in France, Italy and Spain offset the dip in Germany. Even in Germany, where a drag in autos caused GDP in the third quarter of 2018 to go into reverse, leading indicators point to stabilisation with an uptick in new orders, suggesting output will follow. Whilst stabilisation seems to have arrived, the eurozone economy remains on shaky ground and this will likely constrain performance in this area.
Trade tensions and Brexit
Risks related to trade tensions between the US and China have dissipated somewhat, and it looks increasingly likely that a trade deal will be signed between the two nations over the next couple of months. Fears of an all-out trade war had been weighing heavily on global growth and trade; with this headwind removed, we expect to see a pickup. There are concerns that Trump, having dealt with China, could turn his attention to Europe with a focus on autos, which would hurt Germany especially. However, the implementation of auto tariffs isn’t our base case.
Here in the UK, Brexit woes continue, with Parliament still unable to reach a majority in favour of any kind of deal – be that a customs union, no deal or Theresa May’s thrice-defeated official Withdrawal Deal. A series of indicative votes by Parliament saw them wrestle control of the process away from the cabinet, with the outcome increasingly looking like a softer Brexit, although this is by no means certain. Whatever the details of the eventual Brexit deal, the UK’s prospects are set to be uncertain for many years to come. The ever-important housing market reflects this backdrop, with prices falling particularly sharply in London, and whilst the economy remains sluggish, it hasn’t stalled.
Central banks adopt dovish stance
Central banks have tilted towards the dovish side, with the European Central Bank recently postponing the return to normal monetary policy with the announcement of a new round of TLTROs (Targeted Longer-Term Refinancing Operations, which provide financing to credit institutions), as well as forward guidance that no rate hikes are likely to occur before 2020.
Fears of an overtightening of US rates have eased after the US Federal Reserve (Fed) unexpectedly shifted to a far more dovish stance in their first meeting of 2019, citing slowing growth outside the US as a reason to pause the hiking cycle. This stance has been reinforced in subsequent meetings, with the Fed lowering their interest rate projections for 2019 and 2020 at the March meeting – they are now calling for zero hikes this year and one in 2020. This was even more dovish than consensus expectations. A planned gradual taper in the balance sheet run-off was also announced. This continuation of relatively easy financial conditions remains supportive for equity markets. The inflation environment remains benign.
While the first quarter reporting season in the US is likely to be difficult, global earnings are still likely to show reasonable growth in 2019. Whilst investors are anxious about the outlook for corporate margins, top-line growth should be robust.
Overall, noise at both a macro and political level remains, and we should expect volatility to remain elevated. Global growth is likely to undergo a recovery through 2019 as a pickup in China following fiscal stimulus, the improving outlook for manufacturing and consumer spending and the receding threat of a US/China trade war feed through. Solid corporate earnings growth and the limited risk of a near-term recession should help to underpin the equity market and enable progress.