2019 may be starting with a bang in equity markets, but the major economies of the world are slowing down markedly…
But which slowdown should we fear the most ? China’s or America’s ?
The latest releases of economic data relating to the third quarter of 2018 are darkening the mood at Davos’ World Economic Forum.
From the IMF reducing its projections for the year to Chinese GDP numbers, Italy’s weak projections and the collapse in US consumer confidence, things are not looking rosy.
As usual, the press is full of China-negative bold titles such as “The lowest growth rate since 2009” but we hear far less about what is taking place in the US in the wake of the Government shutdown and the 4th quarter meltdown in equities.
So let’s take a look at the facts and figures for the various economies.
Our readers will remember that our Key Investment Call # 1 for 2019 is a global DEFLATION SCARE and this is exactly what seems to be in the making.
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The International Monetary Fund cut its forecast for the world economy, predicting it will grow at the weakest pace in three years in 2019 and warning fresh trade tensions would spell further trouble.
In its second downgrade in three months, the lender blamed softening demand across Europe and the recent weakness in financial markets. It predicts global growth of 3.5 percent this year, beneath the 3.7 percent expected in October and the rate in 2018.
“The world economy is growing more slowly than expected, and risks are rising,” Managing Director Christine Lagarde told reporters in Davos, Switzerland.
The outlook is more upbeat than that of many investors, including ourselves, who openly fear a U.S-led slowdown taking hold.
The fund left its projections for the U.S. and China unchanged and even anticipates a pickup in worldwide expansion to 3.6 percent next year.
Risks nevertheless “tilt to the downside,” the IMF said in a report which came hours after China revealed the slowest expansion since 2009 last quarter.
Among major economies, the deepest revision was for Germany, which the IMF now sees expanding 1.3 percent this year, down 0.6 percentage point from October. Soft consumer demand and weak factory production after the introduction of stricter emission standards for cars was behind the shift.
The fund also cut its forecasts for Italy, citing weak demand and higher sovereign borrowing costs, and France, where the so-called Yellow-Vest protests have hurt the economy. The overall euro area will grow 1.6 percent this year, 0.3 point below what it previously thought.
The IMF lowered its 2019 outlook for emerging markets to 4.5 percent, down 0.2 point from three months ago. A major factor was a deeper-than-expected recession in Turkey, which has been struggling to respond to the plunge in its currency last year. There was also a big downgrade to Mexico’s prospects.
While some of the issues in Europe may be temporary, the IMF noted that they came amid a backdrop of global trade policy uncertainty..
President Donald Trump and President Xi Jinping have given their officials until March 1 to reach a deal on a lasting truce after imposing tariffs on each other last year.
“The possibility of tensions resurfacing in the Spring casts a shadow over global economic prospects,” the IMF said. It predicts global trade volumes will rise 4 percent this year and next, the same pace as in 2018 but below the 5.3 percent of 2017.
The 2019 U.S. forecast was unchanged at 2.5 percent. But the IMF said growth in the world’s biggest economy will cool to 1.8 percent in 2020 as stimulus from tax cuts fades and the economy responds to higher Federal Reserve interest rates.
As for China, the IMF still expects expansion of 6.2 percent this year after 6.6 percent in 2018, a slowing due to the trade war and the government’s attempt to pare leverage.
Now the interesting part of the IMF report is that it focuses on risks coming out of China and not on the risks coming out of the US, which we are much more concerned with.
China released its latest economic data yesterday and they revealed a slightly stronger end to a weak quarter. Moreover, Consumption, the priority of the Government remains on an uptrend.
China’s GDP growth edged down from 6.5% y/y in Q3 to 6.4% last quarter, in line with both the Bloomberg median forecast of economists .
GDP growth for 2018 as a whole was 6.6%, down from 6.8% in 2017, and actually better than the 6.5 % projected by US and most economists.
There were some positive surprises in the monthly data.
Growth in industrial value-added picked up from 5.4% y/y to 5.7% in December. This uptick comes despite weaker foreign demand – growth in industrial sales for export fell back last month from 7.6% y/y to 4.1%, melanin g that domestic demand was stronger than expected.
The service sector growth strengthened from 7.7% y/y to 7.9% in the fourth quarter, there again indicating that domestic demand may be stronger than expected.
Stronger consumer spending has certainly helped – retail sales growth edged up in December, rising from 8.1% y/y to 8.2% .
On the negative side, capital spending remained subdued. Fixed investment expanded 5.9% y/y in 2018 down from 7.2% in 2017. This was driven by a drop back in property and manufacturing investment which more than offset an acceleration in infrastructure spending.
In sum, the latest data suggest that China’s economic growth is slowing down at the pace that is normally expected for an economy that is maturing and transitioning from the export-led model to the consumption-led model.
6.6 % annual growth for a 12.2 Trillion economy means another US$802 billion of GDP per annum for the world economy, or adding an economy of the size of The Netherlands every year.
By contrast America’s 3 % GDP growth last year only added US$ 582 Billion to the world GDP.
Moreover, the fine prints show that China is actually succeeding at transforming its economy into a service and consumption economy and that it has weathered the Trade War relatively well so far.
The strong numbers of the retail sales and the service sector growth – already the largest of all sectors in China – and their re-acceleration in December are indicating that the domestic economy remains strong and that policy measures are starting to have an impact.
Moreover, the Chinese Government is taking the matters extremely seriously and in a highly unusual way, XI Jing Ping warned an exceptional seminar of the regional Party heads of ” The Dangers lying ahead ” paving the way for the announcement of major reforms to stabilize the economy and open its capital markets.
A major development should be the implementation of wide ranging tax cuts for individuals and small companies.
The recent easing in monetary policy still has to produce its effects on the economy and we expect a truce – or at least a pause – in the Trade War with the US, and even a lifting by the US of the tariffs imposed on Chinese imported goods.
Finally, and something that is commonly forgotten by foreign commentators is the sharp rise in Chinese consumer confidence in 2017 and 2018. Consumer confidence is a major determinant of future consumption and economic growth and it is interesting to note that despite the sharp fall in china equities, Chinese Consumer confidence is at almost record highs and climbing again in December.
All these measures should have a positive effect on China’s economic growth in the second half of 2019 while the headwinds of the lagged impact of slower credit growth should keep the first half weaker.
Another positive factor is the surprising strength of the economies of China’s neighboring countries.
As a matter of example, economic growth in Korea was surprisingly strong last quarter.
According to the data released yesterday , Korea’s economy expanded by 1% in seasonally-adjusted q/q terms in Q4, up from 0.6% in Q3. The outturn was much stronger than expected (Bloomberg median: 0.6%)
Growth also picked up in y/y terms, rising to 3.1%, from 2.0% in Q3. Overall the economy grew by 2.7% y/y in 2018, stronger than most economists expected.
The breakdown of the data showed that government spending grew at 7.1% y/y, its fastest pace since the start of 2009. The pick-up in growth was also driven by a smaller drag from investment. While investment continued to contract in y/y terms, it rose in q/q terms for the first time since the start of the year.
Both export and import growth picked up in Q4, net trade contributed roughly the same to GDP growth as in Q3.
Looking ahead, there will be some support to growth in 2019.The planned 10% rise in government spending in the 2019 budget is set to be the largest increase since 2009.
Korea’s numbers should be followed son by Indonesia, Taiwan and Singapore and the advanced indicators for all of them seem to point to a re-acceleration in the 4th quarter of 2018.
China’s Annual GDP Growth rate
China’s Service Sector GDP
China’s GDP per Capita
China’s Consumer Confidence
By contrast to what is being related in the press in general, we are much more worried about a sharp slowdown in the American economy in the coming two quarters.
And our fears are based on two elements, the importance of the wealth effect on consumption and the psychological and economic impact of the now 31-day long Government shutdown.
US consumers are highly leveraged and live on credit. The fluctuations of their assets and retirement plans have an outsized impact on their propension to consume and we have had the worst 4th quarter in more than a decade in the US stock market.
Interestingly enough, this was immediately reflected in the biggest slump in consumer confidence since 2000 according to the University of Michigan release last week.
The University of Michigan’s consumer sentiment for the US fell to 90.7 in January of 2019 from 98.3 in December, well below market expectations of 97.
It is the lowest reading since October of 2016. The decline was primarily focused on prospects for the domestic economy, with the year-ahead outlook for the national economy judged the worst since mid 2014
Even more worrying than the number itself, it is the gap between the actual number and the expectations that reveals the size of the problem.
America is a country where data prediction and surveying is a science and where numbers are relatively accurate.
The latest figure gap is truly exceptional and has never been seen since the data exist in 2000, not even in 2008 in the midst of the financial crisis.
What this means is that something BIG is happening in the US and such a sharp fall in consumer confidence is bound to have a major impact on consumption in the coming weeks and months.
The second element that worries us considerably is the impact of the Government shutdown on the economy.
The shutdown now represents a full month – 1/12th of the year- with 800’000 civil servants not getting paid and major Government services not spending the money they usually do.
In an economy where Government spendings represents 37 % of the GDP, even if the majority of the crucial departments are already fully-funded for the year, the impact on final GDP will certainly be significant.
Moreover, it is likely that the effects of the shutdown will be more lasting than expected as a proportion of Civil Servants are likely to leave and find jobs in the private sector and that it will take months for the services to run back at full capacity.
It is obviously too early to have the impact of the shutdown in the economic numbers, but there is no doubt that it will be negative.
Moreover, it is happening on the back of an extremely negative quarter for stocks which will also have an impact in Investment decisions by CEOs.
Finally, all the data that came out since the beginning of January are already showing a significant slowdown, apart from employment.
The Manufacturing PMI was lower than expected, mortgage application collapsed -8.5 %, ISM manufacturing was down sharply and mush lower than expected and new orders are also collapsing.
This in turn will trigger worries for the second quarter and will have significant consequences for the job market and inflation in the coming quarters.
Another interesting element is that the Government Shutdown might be the straw that is going to break Donald Trumps’ political back.
American voters have witnessed with disbelief US$ 5 trillion being wiped out of US equities oil the 4th quarter because of Donald Trump’s trade war with China and now even his stauncher supporters are seeing their Government being shutdown for a wall that they do not really care about.
Two years ago, many Americans voted for Donald Trump in rejection of the status quo. They wanted to send a message to the political establishment and liked the idea of a disruptive president.
But two years after his inauguration his ties with these voters in key pockets throughout the industrial Midwest and flipped previously Democratic states to him are fraying.
The Government shutdown fight, as it has played out over the past month, is clearly eroding his support among voters who like the idea of beefing up border security, but not enough to close the government.
According to surveys and press reports, even those who still support Donald Trump, say they hold him most responsible for the shutdown and the recent stock market decline.
Voters seem to have listened to his comment from the Oval Office that he would be “proud to shut down the government.”
Recent polling indicates that the government shutdown has caused skittishness among parts of Trump’s base, which has been one of the most enduring strengths of his presidency.
A new NPR/PBS NewsHour/Marist poll, conducted Jan. 10 to Jan. 13, found his net approval rating had dropped 7 points since December.
One of the biggest drops came from suburban men, whose approval rating of Trump fell a net change of 18 percentage points, while evangelicals and Republicans also dipped by smaller margins. Among men without a college degree, the downward change was 7 points.
The shutdown standoff has poked holes in Trump’s ability to say that he cares for the working class, given that 800,000 federal employees and additional contractors going without a paycheck.
Reading from the press report, there seems to be a countrywide nagging concern that an economic downturn is coming, in part because of forces that Trump has unleashed.
There again, the general sense of unease does not bode well for either consumption or investments.
The unease is spreading to the board room with American executives especially worried, according to PWC. The number of them declaring themselves optimistic fell to 37 percent from 63 percent last year.
Corporate America is clearly telling Donald Trump that he must end the Trade War with China and remove the Tariffs and Main Street is telling Donald Trump that they want a functional Government.
Rather than focusing on China’s slowdown, Investors would be better advised to brace for the BRUTAL and SIGNIFICANT SLOWDOWN the we expect in the US in Q1 2019.
As highlighted in the IMF update report published on Monday, Europe is the weakest region of the world and buy far the one giving the sharpest indications of a global slowdown.
Among major economies, the deepest revisions were for Germany and Italy, respectively the largest and third largest economies of the Euro zone, but even France, the second largest is showing signs that the Yellow Vest movement is taking its toll on the economy.
The third quarter figures were already weak and investors are now fearing the publication of the 4th quarter numbers.
What we fear the most is the collapse in Consumer Confidence across the continent as we see no catalyst for a change, apart from a clear end to Donald Trumps’ Trade Wars.
The Euro Area economy grew 1.6 percent year-on-year in the third quarter of 2018, a sharp slow down from the 2.2 percent expansion in the previous period. Data for the 4th quarter should also be on the week side.
The consumer confidence indicator for the Euro Area collapsed to -6.2 in December 2018, the weakest reading since February 2017, due to a deterioration of all its components.
The German economy shrank 0.2 percent on quarter in the three months to September of 2018, after a 0.5 percent growth in the previous period. This was the first quarterly contraction since the first quarter of 2015 due to declines in both exports and household consumption.
The GfK consumer confidence index in Germany stood at 10.4 heading into January 2019, unchanged from the previous month and slightly above market expectations of 10.3.
Still, it remained the lowest reading since June 2017, amid persistent worries about the trade conflict between the US, China and the EU, as well as uncertainty caused by Brexit negotiations.
France’s quarterly economic growth was revised lower to 0.3 percent in the three months to September 2018, compared to a 0.4 percent previously estimated and following a 0.2 percent growth in the previous period. The negative contribution from inventory changes was bigger than initially thought.
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The French consumer confidence indicator fell to 87 in December 2018 from a downwardly revised 91 in the prior month, below market expectations of 90.
It is the weakest reading since November 2014, as the willingness to make major purchases fell sharply below its long term average to its lowest level since June 2013. Households’ opinion balance concerning their future financial situation decreased again along with expected saving capacity and worries about unemployment increased.
The Italian economy unexpectedly shrank 0.1 percent quarter-on-quarter in the third quarter of 2018, following a 0.2 percent growth in the previous period. It was the first contraction since the second quarter of 2014.
Italy’s consumer confidence index declined to 113.1 in December of 2018 from a downwardly revised 114.7 in the previous month and missing market expectations of 114.
It was the lowest reading since August 2017, as all sectors registered a drop in confidence. There was a deterioration in households’ sentiment regarding the economic climate, current conditions and future situation.
Even in Switzerland, traditionally a haven of growth and well-being, the climate is deteriorating sharply.
The Swiss economy unexpectedly shrank 0.2 percent on quarter in the three months to September 2018, after a 0.7 percent growth in the previous period and missing market expectations of a 0.4 percent expansion.
It was the first quarterly contraction since the fourth quarter of 2016, as net trade contributed negatively to the GDP and investment in equipment slumped while household consumption was almost unchanged.
The Swiss consumer confidence index remained in negative territory even but edged up to -6 in the December quarter 2018 from -7 in the previous quarter while markets estimated -8. For once, Consumers were slightly more optimistic about the country’s economic growth.
In sum, we fear that the world economy will slow down markedly in the 1st quarter of 2019 and that the main negative surprise will come from the US and not from China.
Donald Trump’s Trade Wars and Government shutdown have unleashed powerful deflationary forces the negative impact of which will take months to fade away.
Only a clear and swift resolution of both can create the conditions for a resumption of global growth
China and Asia will most probably take the lead of the economic recovery in the second half of the year.