2018_11_26 — “Global Economic Expansion is Off”

November 26, 2018

Global Economic Expansion is Off

Global economic expansion is off

• US/euro area momentum has weakened
• The UK is fragile
• China remains in a controlled slowed down yet still bent on global dominance
• Japan and Korea continued to lose steam
• India is long-term positive but short term embroiled in red tape
• Weakness in the US won’t help a still struggling Mexico

Global economic expansion is off. Global expansion has become much less synchronized over the past six months with leadership slipping. The US and a few developed markets are holding the baton as the combination of a moderate slowdown in Chinese activity, disruptions in India, a stronger dollar, and weaker oil prices have weighed on global and emerging market momentum. Global trade growth peaked a year ago; global manufacturing PMIs has been falling since spring. Trends still point to global economic growth, just not the robust growth of 2017; weakness in third-quarter GDP in Germany and Japan has shifted sentiment. Fear that the UK could leave the EU in a disorderly fashion and that Italy is in a debt crisis also weigh on global markets. Prospects of a slowdown in global growth have triggered a sharp drop in oil and other commodity prices. Escalating protectionism and tighter Dollar funding conditions have created a major cyclical turning point. US equity markets are re-testing the lows reached in late-October, corporate bond spreads are widening and Treasury yields have declined. Short term and long term risks have increased, with prolonged trade frictions raising the likelihood of self fulfilling financial market weakness that could, in turn, trigger a broader deterioration in credit conditions.

The global supply glut of the last few years has not been resolved and will weigh on growth. The US has maintained its tight labor market and strong job creation, causing wages to slowly creep up. However the euro area has not been able to step out of its current soft pouch; German Italian leading indicators have disappointed. China’s controlled slow down has weighed in on indicators for Japan, Korea, and Australia. In addition, the Made in China 2025 plan will replace some of the need for Japanese, Korean, and Australian imports.

Europe may be turning over again, which will reignite fears of a Euro break up. Brexit it has much to do with the UK going forward; but it has even more to do with how the euro area might handle other more serious defections (e.g., Italy) down the line. Italian binds already trade like junk debt. Worries about Italy will intensify in 2019 as growth slows, the budget deficit widens, and the ECB starts to tighten monetary policy; remember Greece in the run-up to the European sovereign crisis.

The risk is that political or trade disruptions short circuit the pick up in capex while Fed hikes flatten the yield curve prematurely, bringing forward the cyclical peak. Credit spreads in the US will rise next year as the cumulative effect of monetary tightening sharply slows the economy. In the United States, there seems to be much less concern than five months ago about flattening yield curves and more concern about the Fed raising rates. The US Fed will raise rates another quarter percent in December; market reaction will hinge on the language the Fed uses in their statement. Christmas retail sales will be stupendous, but these can be quickly overshadowed by economic expectations reigned in by a continuously hiking Fed.

Tariffs may be maintained and increased. Market sentiment this week will be driven by trade negotiations between the US and China, ahead of the proposed meeting between Presidents Trump and Xi at the G20 summit at the end of November. While Trump appears confident that a deal is in the making, members of his administration have hinted otherwise. Expect Trump to maintain his tough stance because fundamentally this is not about trade but about restraining China’s global ambitions.

Michael Ashley Schulman, CFA

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Disclosure: The opinions expressed are those of Michael Ashley Schulman, CFA and are subject to change without notice. The opinions referenced are as of the date of publication, may be modified due to changes in the market or economic conditions, and may not necessarily come to pass. Forward-looking statements cannot be guaranteed; neither can backward-looking nor current-looking statements. This material is provided for informational purposes only and does not constitute an offer or solicitation to purchase or sell any security or commodity or invest in any specific strategy. It is not intended as investment advice and does not take into account each investor’s unique circumstances. Information has been obtained from sources believed to be reliable, but its accuracy, completeness and interpretation cannot be guaranteed. Past performance is no guarantee of future results.