In his most recent note, published yesterday, Neil Shearing, Group chief economist at Capital Economics, says that the swift worsening of recent macro data has led him to ask whether he and his colleagues might be missing something more serious. For context, Capital Economics was already quite bearish on the global economy in 2019, forecasting global growth of 3% this year and less than that the next. So what might we all be missing? Four things stand out. First, we may be underestimating the fallout from global “trade wars.” The second – and more ominous – thing Shearing says we may be missing is that financial strains could be building in the world economy (the sharp contraction witnessed in the past 6 months). Third, it’s possible that we may be underestimating the extent of the slowdown in China, and fourth, it may be that we’re not missing anything at all, but the fact that the global economy is now more inter-connected means that feedback loops are amplifying the effects of slowing growth in each of the world’s major regions, says Shearing. These may have boosted growth in 2017, when the world experienced a synchronised upswing. But we may now be experiencing this in reverse, he concludes.
There are two major economic stories unfolding now, writes Erik Nielsen, chief economist at Unicredit. Getting this picture right will be critical for the monetary policy response, he adds. These two stories are the growing evidence of a cyclical downturn, and the abrupt slowdown in global trade. The economic backdrop is looking pretty bleak, particularly in Europe, where last week’s fifth consecutive monthly decline in the German Ifo raises the probability of a recession in Germany in H1 2019 to 38% according to Unicredit’s models. What worries Nielsen, is the muddled picture coming from Central Banks, and the potential for a policy mistake, as the global economy enters what he describes as a ‘’pretty normal cyclical downturn.’’ That’s because there seems to be a degree of confusion among central banks and market participants on what might be considered a pretty standard approach using monetary policy to counter the negative effects of the downturn. Add to this, there’s the man made (self-inflicted) stuff – the trade wars – which has hurt sentiment and consequently is feeding through into this slowdown. Nielsen reminds his readers that additional tariffs have only hit 2% of total global trade and Brexit hasn’t happened yet, so this is still early days. It’s this deteriorating sentiment that should be countered by monetary policy, he says. That’s why Nielsen was somewhat perplexed by the response of ECB’s Draghi last week. Given European data has fallen off a cliff, the crux of the ECB meeting was ‘’essentially devoted to an assessment’’ in the words of Draghi. Far far too timid says Nielsen. He sets out the likely policy responses that will be required by the ECB in the coming months, including a TLTRO-like operation, and if things get really bad, a semi-co-ordinated fiscal expansion across the eurozone. Click below for the full note.
The Capital Observer has a good recent track record in risk assessment, having last summer successfully identified that the S&P500 was approaching a long term “high risk” position. The publication remains cautious in its January edition, arguing that initial support may still be a month or two away, before a potentially strong mid-year equity rally. Gold should continue to push higher in the short term. The market’s view that the Fed may not raise rates in the whole of 2019 is seen as a “pipe-dream”. Rates will have to rise in the second half, which may lead to at least a technical recession in the first half of 2020. The S&P500 therefore is likely to see another strong sell-off towards year-end.
Recession probability in the US remains minimal in the next six to nine months, and the Fed may hike once or twice more before reaching a neutral rate, Ned Davis argues on January 17. At three years, the current tightening cycle is already the longest on record by far. The 10-year yield peaked about before the December hike, consistent with the past three cycles where yields have peaked at or before the end of the cycle. Tightening cycles have been explored in depth by Ned Davis in The Fixed Income Tightening Cycle Handbook, published in September 2015. Ned Davis is currently underweight equities, overweight bonds and underweight cash.
China’s regulators are increasingly looking to signal support for the economy, while not actually doing much to change or intensify concrete policy measures, say Trivium, a specialist China politics and macro research firm, in their January edition of Trivium Macro. The key outcome of the unusually measured policy response, add Trivium, is that it will take longer than in past downturns for the economy to stabilize. Also see this compilation of Trivium’s daily Tip Sheet, which you can subscribe to free of charge and which will give you daily highlights of much of the recent newsflow around proposed stimulus measures, including the spat between PBoC and MoF on the idea of introducing some form of QE.
In a piece published on January 22, Datatrek takes up Yardeni’s point about reduced earnings estimates not being followed by revenue. Sales growth is likely to exceed profit growth in the first and second quarters, and margin contraction is a typical late-cycle problem as labour and input costs take their tolls, Datatrek argues. Trade tariffs and slowing global growth will put further pressure on margins. An earnings recession in the first half is clearly possible, and full-year S&P earnings estimates are still too optimistic unless the US-China trade dispute gets fixed quickly. Expect 2019 earnings estimates to keep being cut as the fourth-quarter reporting season unfold.
Negative news on the global economic outlook has filtered through to industry analysts who have been scrambling to lower their earnings estimates for this year, Yardeni Research argues on January 24. Yardeni queries whether they should be doing the same for revenue estimates, which have held steady since the end of October. Chastened corporate outlooks, however, still have their price, and Yardeni argues that forward P/E S&P ratios reached their bottom on December 24. US inflation and interest rates are forecast to remain low, which should continue to aid the valuation recovery.
The days of large Chinese current-account surpluses are over, Gavekal argues on January 16. The renminbi will therefore become more sensitive to capital flows and so more volatile. In turn, that means that the currency should avoid becoming seriously under- or overvalued. The Chinese economy is now so large that its exports are likely to grow at around the same rate as global exports, rather than consistently outperform, Gavekal says. The domestic economy is now in a cyclical downturn which means that commodity prices are more likely to weaken in 2019 than to rise. That point is underscored by the fact that the government’s moves to pump up demand have so far focused on tax cuts for households and corporates rather than stimulating housing construction.
Negative sentiment on oil is based on laggard US oil inventories and is likely to end by the end of the first quarter, according to the January issue of The Capital Observer. The sell-off in oil was driven by slow US demand and consumption of crude oil and petroleum, but that was a seasonal feature that will soon end. Inventory builds have ended, and drawdowns will continue as all precursors such as refinery oil input and gasoline production have been accelerating. All themes in the oil universe are set for a strong bounce in mid-year. The Capital Observer favours the usually larger, more integrated European companies as opposed to their US counterparts, as well as versus the more cyclical segments of the market. We highlight just one section of the Capital Observer monthly report, which provides comprehensive tactical cross asset allocation strategy. Their track record in 2018 was impressive. Overall they are very cautious of this recent risk rally and warn their clients against turning too positive too quickly. Indeed, they expect risk assets to resume their downtrend, probably retesting their December lows towards mid/late February, perhaps March.
Investors have grown used to panicking early and often over the past decade, yet a recession this year is less likely than current market pricing suggests, according to a report by MRB Partners on January 16. In fact, the latest investor panic may have bought some more time by encouraging the Fed and the ECB to delay, and the US and China to negotiate a trade truce. An engine that will keep the US economy going is homeownership rates among buyers under 35, which fell substantially over the past decade, leading to huge pent-up demand. When it finally arrives, recession globally, and especially in the US, will be short and/or shallow. The smaller developed economies, including Australia, Canada, Hong Kong, New Zealand, Norway, Sweden, Switzerland and the UK, are the “canaries in the coalmine” for the next global recession. Financial stocks in these countries are underweighted. US and euro area bank are seen as having deep locked-in value and are overweighted. MRB Partners will publish Part II of its forecast this week.