Having tackled the prickly subject of politics in the first of our Summer Series of Blogs (click here for that piece) today I am going to outline our views on the global economy as we head towards 2019. As we entered this year, our view was that while growth was strong and seemed likely to be very healthy in the first half of the year, this period was likely to be “as good as it gets” for the global economy. Whilst we made this projection with a number of cowardly caveats (and it is fair to say that this view has been properly stress tested through the last seven and a half months), so far it has been proven right. What has been most interesting is the evaporation of last year’s en vogue economic phrase “globally synchronised expansion” as we have started to see a growing divergence in fortunes around the world. The easiest way to sum up this split is that the US is doing well, Europe and Japan are doing “ok” and the emerging market (EM) world, led by China, is slowing.
The biggest question to answer is whether parts of the world can “march to the beat of their own drum” for long or whether a convergence of economic direction is likely. I’ll save my views on that demanding question for the conclusion.
Let’s start with the good news. The US economy is clearly benefitting both from the significant tax cuts and the aggressive deregulatory efforts of the Trump administration, the latter of which I believe has been materially underappreciated, which mean more money in the pockets of everyone in the US and less hassle for businesses. This is perhaps most evident in the historically high levels of US small business confidence, which suggests that US companies are just about as confident as they have been in three and a half decades. That is quite a change from the depressed views of businesses in the Obama years and, all things being equal, this should continue to lead to more investment, higher wages and, by means of a positive feedback loop in the US economy, growing corporate profits. There is nothing to suggest that this positive backdrop is going to end anytime soon, even if there some concerning signs in the housing data and timely data suggests a lower rate of overall growth than we have seen in the last six months. Moreover, it would be irresponsible for us to ignore the structural weaknesses the US has, such as worryingly high debt levels in a rising rate environment (a discussion point for my next Blog) and the potential for further trade disruption, both of which we believe are icebergs floating in the not too distant future.
Europe has been a disappointment so far this year, as lofty expectations that analysts held at the start of the year have not been met. Our view was always that people were too optimistic on the Eurozone, but that growth would still be positive in the region.
In our view, the reasons for the shortfall in achieved growth come down to concerns over a potential trade war, in which Europe would be very vulnerable, and persistent low levels of investment by Germany. Of course, problems over debt still plague the periphery, even if contagion from an increasingly unstable Italy has not spread to the other Club Med nations over the last few months. In simple terms we expect economic growth across the Channel to be mildly positive for the foreseeable future, particularly while monetary support remains in place, but we can’t shake off our medium term views that Europe is the greatest problem for the global economy and that debt and demographics will be the ball and chain that force Europe to drag its feet for the next few decades. Certainly European governments can help alleviate some of that heavy burden through necessary reform and more pragmatic policy making, particularly in the case of Germany, but we feel strongly that Europe missed its chance to repair the roof while the sun was shining and the European Central Bank provided an umbrella to shield it from the rain. With that umbrella being gradually pulled away and then shut at the end of the year, (again another discussion point for the next blog in this series), we don’t think it will be too long before Europe’s issues start waves across the world.
So that’s dealt with the “good” and the “ok” elements of the global economy, so let’s move onto the “bad” and, in some cases “ugly” aspects of 2018 so far. Undoubtedly many parts of the emerging world are under real pressure, which has been increasingly reflected in the prices of the currencies and assets in those problem areas, of which Turkey and South Africa are the two obvious examples at this time, but much of Latin America cannot be ignored. Turkey and South Africa have common emerging market problems of structural economic deficiencies and concerning political situations. Whilst the slowdown in growth and rise in financial fears might be insufficient to knock the developed world off its positive growth path, any retraction of capital away from the emerging world or a further rise in borrowing costs at a time when a large amount of debt needs to be refinanced, will be unhelpful and is a very different environment from the “globally synchronised expansion” of 2017.
The question that investors must ask themselves is whether they are comfortable that the build-up of debt in the emerging world over the last 10 years is serviceable or whether issues around the debt pile will lead to a much slower rate of growth.
China was an obvious source of concern for us as we entered 2018. To be clear, this concern was not over the potential for a recession or the “hard-landing” that the pessimists have forecast repeatedly for the last decade, but rather we felt that the positive impetus derived from the major stimulus applied to the Chinese economy in 2016 would start to wane and we felt strongly that most commentators had underappreciated this dynamic upon growth across the world. It would now appear that a slowdown is taking place in China, with the most recent data set from the Middle Kingdom all pointing towards a lower growth rate. There are two important things to always note with the increasingly important Chinese economy; firstly, whilst growth rates have slowed, China is a much bigger beast than it was even a few years ago, and while growth is slowing the current levels of output generation is sufficient to support the overall global economy. Equally important is the fact that the Chinese authorities want the economy to slow, within reason, so that some of the excesses of stimulative efforts of the last decade can be unwound and a rebalancing of the economy towards consumption can take place. Our job as investors is to work out whether the growth slowdown is too fast or whether the Chinese authorities still have control. We believe that the authorities remain in charge, even if they have a perilous task ahead and the chance of an “accident” has risen. However, the clear message is that China’s future economic potential will be lower than the breakneck speed of the last three decades and that this means the world’s trend growth rate is therefore lower than we have experienced over that period.
To us the global economy looks like it is in a “Goldilocks” period, where growth in neither too hot nor too cold.
However, when we break down the overall picture we find parts of the world that are hotter and colder than others, as well as bits where the potential for overheating or cooling too much is high. It is certainly a lot more complicated than it was last year and the future is uncertain. To return to the question posed at the outset, we would expect the overall rate of the global economy to slow as we head towards next year, not least as in a globally connected world the reduced potency of China and the EM world will weigh to a degree upon the US and Europe. That being said, the balance of positives and negatives are finely balanced and keeping a very “open-mind” is absolutely vital when one considers the interlinkage between the economic outlook and an investment strategy.
Chief Investment Officer
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