Given the sharp rally for risk assets since the start of 2019, investors are eager to detect the green-shoots of a growth revival as spring beckons. As we said in last week’s note, much of the focus is on the state of China’s economy and progress in trade talks with the US. The coming weeks will be pivotal in convincing markets that a rebound is underway across G7 economies. A homegrown impetus looks to be the priority, especially in the eurozone as global trade growth fades.
Last week the markets were encouraged by stronger than expected US data with Q4 GDP growth at 2.6% (annualized). True it was markedly weaker than the 3.4% of the previous quarter, but consumers are proving to be remarkably resilient. Consumer spending rose at a 2.8% rate of growth despite all the political noise. Non-residential investment spending was also robust. Economists’ forecasts for the current quarter took a further slip in growth as the fiscal stimulus fades, but some positives should support the slowdown. Financial conditions have improved relative to late last year, and the government shut down has ended. Indeed, as Fulcrum Asset Management pointed out recently, the chance of US economy producing above-trend growth in the next 12 months has fallen to 20% from around 90% a year ago but the risk of recession over the same period is, in their opinion, negligible. The rate of GDP growth is now definitively past its peak, but Goldilocks is again a US resident even if the Fed remains afraid of the international big bad wolf.
The outlook for the eurozone, as usual, looks more tentative – Germany has just avoided a technical recession, but for the region as a whole a recession remains a real risk. The German Ifo business climate indicator stood at its lowest level in four years in December; similarly, Spain’s manufacturing sentiment is at the lowest in five years. Structural issues are emerging all across the famed German export engine, so consumers are now getting much attention. Many economists are anticipating a genuine revival this year – German retail sales rebounded sharply in January after a dismal December. The expected source of support alongside easier credit conditions is wage growth. Absolute Strategy Research suggests that wage growth per eurozone employee is now running at over 2.5% year on year from a trough of 1% in 2016. It cannot be described as a bonanza but combined with a general pickup in residential real estate values (outside Italy), it does offer a crucial underpinning to domestic revival and GDP expansion of at least 1.5% in 2019.
As has proved to be a repeated theme in recent years, equity investors globally are still hooked on the need for a Chinese fiscal or monetary stimulus. All the more so when pressures on Chinese overseas trade practices are being cranked up in a way that the Chinese authorities are unaccustomed to. There was better news of a type last week with the Caixin-Markit China manufacturing purchasing managers index increasing to 49.9 in January almost back to the 50 level that marks ‘expansion’. This indicator captures more of the unregulated smaller, independent, labour–intensive businesses that may be needed to drive future dynamism in the economy. Certainly, it does look like the Chinese consumer will be pivotal and therefore the target for any government largesse this year. The IMF project that the Chinese economy will expand by over 40% between 2017 and 2023; already private consumption is contributing the lion’s share of new expansion as its share of economic activity is still well behind that of western economies. Chinese households are a complex, highly competitive market but, as the textbooks on economic development keep saying, this is where the future lies not just for the country but the globe.
Equities are up over 11% in local currency terms over the year to date, reflecting a less threatening macro outlook but as we have said central banks are in a real dilemma as to how far, and when, to continue reduced stimulus/policy tightening. The ECB will meet this week and will update its forecasts on growth and inflation. Renewed balance sheet expansion is off the agenda as the risk of price deflation is much reduced. However, the market is expecting a steer on the timing of rate hikes that should support both bond and equity markets. The US Federal Reserve is only adding to the muddle on its intentions. That lack of transparency on what is driving its thinking is, in itself, a reflection of a much broader, more threatening loss of faith in inflation-targeting and the usefulness of rules based on the labour market. Bottom line, since the end of the financial crisis, inflation is not rebounding in the way that was expected by the Fed or most forecasters. It is today, like most of the last ten years, below the defined target of 2% per annum at the core level. Is it a delayed response or an underlying shift in dynamics? - Time will tell, but right now the Fed has to explain the persistent undershoot. Better to be candid and look at some real policy alternatives to address the situation.
Year-end industrial surveys of business conditions are dominated by the strong momentum around technology and those front-end companies from fintech to food to fashion and health that harness its capacity innovatively. While tech firms are undoubtedly helpful for competition and in a sense offer a subsidy to consumers to access extended networks at minimum cost, the other side of the coin is our increased awareness of their control of user data and tendency to customer ‘prompts’. Legislation to confront this reality is coming down the pipeline and will have to address more in the way of predatory pricing of internet services as well as Big Tech’s tactics of strangling or buying up new competition.
Meanwhile, ‘Deloitte Insights’ in a recent focus on Tech Trends for 2019 highlighted how business dynamics within the sector itself are shifting in a way that could be highly confrontational for the consumer. They see technological innovation moving on from simple analytics that observes data to forms of (I) digital reality (how we interact with the digital world) as well as (ii) blockchain (how we transact and engage with one another) and finally (iii) cognitive solutions. They describe ‘cognitive’ as ‘shorthand for technologies such as machine learning (ML), neural networks, robotic process automation (RPA), bots, natural language processing (NLP), and the broader domain of artificial intelligence (AI)’. Such technologies can, in their view, ‘help make sense of ever-growing data, handling both the volume and complexity that human minds and traditional analysis techniques cannot fathom’. Welcome to the next wave of innovation but be aware that humans may resist the tide.
Authors - Bill O’Neill & Gary Dugan
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