One third of 2019 is already behind us and, to say the least, it has been the heck of a third in the financial markets.
On 31st December 2018, very few commentators expected the equity markets to rally, fear was prevalent and analysts were busy revising their 2019 targets down. On January 3rd 2019, we published a piece titled IT LOOKS SCARY BUT IT IS TIME TO BUY STOCKS and we were spot on.
Since the beginning of the year, he MSCI World Index rose 21.5 % the Nasdaq increased by 23 % and Chinese equities outperformed all markets rising 42 % up till their April 22nd peak.
Over the same period bond yields fell back to the middle of their 2018 range, the US Dollar strengthened and Gold and precious metals have been in corrective mode since the beginning of the year.
Two factors explain this major shift in sentiment :
The world economies slowed down markedly following Donald Trump’s 2018 Trade Wars.
In 2017, the world economy was finally regaining a strong footing and almost every region of the world was growing and pulling out of deflation for the first time since the 2008 financial crisis. This coincident bout of growth has a strongly positive impact on labor markets around the world and inflation figures were finally reaching the targets set by the major central banks of the world at 2 %.
America had started to normalize monetary policy, raising interest rates from 0 % to 2.25 % in 8 different steps and reducing its stock of bonds at a rate of US$ 60 Billion per month, Europe was busy discussing the end of its bond buying program and Japan was again considering a hike in its sales tax to finally attack its massive public debt problem.
In February 2018, the sudden attacks of US President Donald Trump on Canada, Mexico, Japan, Europe and China, cancelling the NAFTA agreements, imposing tariffs of Chinese products and threatening to do the same on Japanese and European products sent a chill on the world economy and mots CEO’s around the world suspended their investment plans by fear of the uncertainty created by this new situation, and even potentially new world order.
America pulling out of a globalized world and moving back to protectionism was not good news for a world that has become so global that borders and state sovereignty are being challenged by trillion Dollar private corporations.
How could anyone think in their right mind that they could protect and/or create jobs in America by putting sanctions on a country that manufactures 90 % of the products of America’s greatest companies.
‘Proudly designed in California and manufactured in China’ reads the packaging of each and every product sold by Apple !
The fact of the matter is that the Trade Wars created a chain reaction that first led to a collapse in investments, then pushed the heavily exporting industrial goods manufacturing economies of Germany and Switzerland into recession and then started to affect consumption and is now finally and ultimately affecting labor markets, including in the USA.
As a result Central Banks around the world have stopped normalizing monetary policies and we are going back towards a deflation scare if oil prices collapse as we expect.
Today, monetary policies are again extremely accommodative in most parts of the world with he native rates in Europe, Japan and Switzerland and negative real interest rates almost everywhere apart from China and the US.
Negative nominal and real interest rates are a powerful fuel for equity markets and the certainty that Central Banks are not about to raise rates anytime soon rightly boosts investors’ confidence, pushing valuations to extremes again.
The second factor that has fueled the equity rally in the first third of the year is the prospects for a resolution of the Trade Wars.
America, Canada and Mexico quickly came to an agreement on a new version of NAFTA, which, according to most specialists does not differ much from the previous one. It may have given Donald Trump a political “victory” with his relatively basic electoral base, but has not done much in terms of changing the terms of trade between the three countries.
The Trade War with Japan and Europe has been more a war of words than an effective war.
Could Donald Trump really go to war – see our article Trade Wars are the Wars of the 21st century and Americe will lose that one,- with its main geo-political allies, Europe and Japan ?
Certainly not !The extremely high level of integration of the American, European and Japanese economies makes a Trade War between these countries almost impossible and , when combined together, Europe and Japan represent Americas’ largest foreign market at 17.5 trillion GDP.Most Japanese and European cars sold in the US are actually built in the US and ver7y few American cars are actually sold in Europe, so any tariff retaliation would actually apply to other American products such as phones, computers, social media services, Boeing, Harley Davidsons, Caterpillar and Massey Fergusson products.Strategically, Europe and Japan are America’s key geo-political and military allies and its world leadership and supremacy will not last if it confronts them.
America needs Europe against Russia and Japan against China and as Britain is pulling out of the European Union, an America + UK against Europe, Japan, Russia and China equation is definitely not in favor of America.
So, despite some late-night show gesticulations about imposing tariffs on European and Japanese cars it is more than likely that nothing there will happen.
That has left the brunt of Donald Trump’s ire on China and the impact has been significant, not only for China but for the rest of the world.
The burst of aggression started in January 2018 and happened at a time where the caginess economy was already slowing down. The Chinese stocks market immediately fell and spent most of 2018 in bear market territory.
After a very limited effect on Trade, Chinese Trade surplus with America started growing again despite the tariffs imposed on Chinese made products.
Indeed, many American corporations who source the components of their products in China had no time to adjust their supply chains, and in today’s highly technological world, replacing high-precision component producers with whom you have worked for years if not decades in close cooperation is not something that can be done easily.
So, ultimately, the additional costs imposed by the Tariffs was ultimately born by the US consumer, or even worse by the profit margins of the US corporations manufacturing in China.
Conversely, American corporations have had to deal with an extremely negative perception in China, the world largest consumer market and a significant shift of consumer preferences in favor of Chinese brands and Chinese made products was visible in all the consumer surveys over 2018.
The full impact of the US China Trade War may very well be seen in Apple’s results to be published tonight and it is already clear that China has taken advantage of the two deadly crashes of BEOIGs 737 Max to reduce their appetite for American made planes.
These asymmetrical consequences were gradually appearing all over 2018 and the double-faced Donald Trump of the Buenos Aires summit in November 2018 sent global equity markets tanking in the last three weeks of the year.
Having dinner with XI Jinping in Buenos Aires while demanding the arrest of HuaWei’s CFO in Canada at the same time is not what the financial community expects from an American President, let alone a world leader.
It is not a surprise therefore that Donald Trump has changed his tack and is now extremely keen on finding a deal with China to resolve the Trade War.
In fact the latest economic figures show that China’s economy has been little affected by the Trade War and is pulling out of its slowdown in a global fashion while America and the rest of the world have plunged into the worst coordinated slowdown since the financial crisis.
China may actually be the real winner of the Trade war and the next two weeks should provide more clues on the extent of the victory as the two camps iron out the last details and the two leaders celebrate an agreement.
China has taken the Trade War as an opportunity to accelerate its economic transition and position itself as a “Respectable and Reliable Partner” of the International community.
It is determined to play the game by te book and make significant commitments for further opening up, the rule of Law, equality of treatment, respect of intellectual property and last but not least a lasting appreciation of the Yuan.
Indeed, the only way to solve China’s structural trade surplus problem is through a lasting and substantial appreciation of the Chinese currency and we may be reaching the tipping point where China may commit to exactly that.
The stage of the world economy being set, it seems appropriate for us to do a proper assessment fo the World Economy’s prospects for the remainder of the year.
THE STATE OF THE WORLD ECONOMY
THE $80 TRILLION WORLD ECONOMY in 2019.
In preamble and as a matter of reflection, we’d like to put in perspective the fact that the capitalization of the US stock market ( NYSE + NASDAQ only ) amounts to US$ 45.5 Trillion today, 2.3 times the size of the US GDP and 56 % of the world GDP while the US only represents 24.4 % of the same.
As always, our macro-economic process will focus on Seven data series that are the backbone of any economy : GDP Growth, Unemployment Inflation Rates, Interest Rates, Consumption, Business Confidence and Money Supply
The chart below from TRADINGECONOMICS summarizes the latest data points for the 15 largest economies of the world, representing 71.96 Trillion Dollars of GDP or 90 % of the world economy.
A Quick analysis of the table above shows that the world is still growing, albeit at a slower pace, that Real interest rates ( Interest Rates – inflation rates ) are still negative in most parts of the world, that Europe is plagued with structurally high unemployment rates and that China and Russia are actually the best managed economies based on pure economic indicators.
Japan, Italy and the United States are the most indebted countries relative to their GDP
Another worthwhile observation is that at 1.57 Trillion, the Russian economy is less than 1/10th the size of the US economy, just between Canada and South Korea.
USA
Growth. The US GDP grew by an annualized 3.2 percent in the first quarter of 2019, easily beating market expectations of 2 percent and following a 2.2 percent expansion in the previous three-month period. Growth was mainly supported by personal consumption expenditures (PCE), private inventory investment, exports, state and local government spending, and nonresidential fixed investment.
Unemployment. The US unemployment rate came in at 3.8 percent in March 2019, unchanged from the previous month’s figure and in line with market expectations. Unemployment is at multi-decade lows in the US. The number of unemployed persons decreased by 24 thousand to 6.2 million while employment dropped by 201 thousand to 156.7 million. The participation rate fell to 63 percent in March from 63.2 in February.
Inflation. The US annual inflation rate rose to 1.9 percent in March 2019 from a two-and-a-half-year low of 1.5 percent in the previous month, slightly above market consensus of 1.8 percent. And this is which record Oil prices that have risen 32 % since the beginning of the year.
Food prices rose at faster pace while energy deflation eased. The core inflation rate, which excludes volatile items such as food and energy, edged down to 2 percent from 2.1 percent in February, just below forecasts of 2.1 percent.
Interest Rates. The FED raised interest rates 9 times since 2016 from 0 % to 2.5 %. It is the only country of the four major economic regions of the world to have truly tightened since the financial crisis.
Federal Reserve policymakers expect rates to remain at current levels this year, compared to December’s projection of two hikes. The FOMC also pledged to start slowing the shrinking of its balance sheet in May and stop the drawdown altogether at the end of September.
With the recent fall in inflation REAL INTEREST RATES HAVE ACTUALLY MOVED IN POSITIVE TERRITORY, explaining the strength of the US dollar.
Consumption. US retail Sales jumped 3.6 percent from a year earlier in March 2019, following a 2.2 percent increase in February, but still much lower than the average 5 % achieved in 2018.
Business Confidence. The ISM Manufacturing PMI in the US rose to 55.3 in March of 2019 from 54.2 in February which was the lowest reading since November of 2016. It compares with market expectations of 54.5.
Money. Money Supply M2 in the United States increased to 14509 USD Billion in March from 14477.80 USD Billion in February of 2019. Money Supply growth is easing after the strength of 2017 and 2018.
Europe
Growth.The Eurozone economy grew 0.4 percent on quarter in the three months to March 2019, accelerating from a 0.2 percent expansion and beating market expectations of 0.3 percent, a flash estimate showed. Among countries for which data is already available, Spain’s economy advanced at a faster 0.7 percent, while French GDP growth was unchanged at 0.3 percent.
Unemployment.The seasonally adjusted unemployment rate in the Euro Area fell to 7.7 percent in March 2019 from 7.8 percent in the previous month and below market expectations of 7.8 percent. It was the lowest jobless rate since September 2008, as the number of unemployed continued to decline. A year earlier, unemployment rate was higher at 8.5 percent.
Inflation. The annual inflation rate in the Euro Area fell to 1.4 percent in March 2019 from 1.5 percent in the previous month, in line with the preliminary estimate and market expectations, final data showed. And that is with record high oil prices. Prices slowed for food, alcohol & tobacco; services and non-energy industrial goods.
Interest Rates. The European Central Bank held its benchmark refinancing rate at 0 percent during its April meeting and reiterated it expects key interest rates to remain at record low levels at least through the end of 2019, amid global growth concerns. The central bank also pledged to keep reinvesting cash from maturing bonds for an extended period of time.
WITH INFLATION AT 1 % AND INTEREST RATES AT 0 %, REAL INTEREST RATES ARE NEGATIVE BY 1 % IN THE EURO ZONE
Consumption. Eurozone’s retail trade rose 0.4 percent from a month earlier in February 2019, following a downwardly revised 0.9 percent growth in January and beating market expectations of 0.2 percent gain.
Business Confidence. The Business Climate Indicator (BCI) for the Euro Area fell to 0.42 in April 2019 from a revised 0.54 in the previous month and below market expectations of 0.49. It was the lowest reading since August 2016, as managers’ views of the past production, their production expectations, and their assessments of overall order books and the stocks of finished products declined significantly.
Money. Money Supply M2 In the Euro Area accelerated sharply to 11888306 EUR Million in March from 11795373 EUR Million in February of 2019, testifying of the effects of the very accommodative policies of the ECB.
China
Growth. The Chinese economy advanced 6.4 percent year-on-year in the March quarter of 2019, the same pace as in the previous quarter but slightly above market expectations of a 6.3 percent expansion. Industrial output growth accelerated markedly and consumer demand strengthened amid government’s pro-growth policies, which helped stabilize sentiments rattled by trade dispute with the US.
Unemployment. Unemployment Rate in China decreased to 3.80 percent in the fourth quarter of 2018 from 3.82 percent in the third quarter of 2018. This record low unemployment rate testifies of the success of China in creating massive numbers of jobs and the rarefaction of available labor. It is one of the reason that will let China allow its currency to rise as part of the solution for the Trade War with the US.
Inflation. China’s consumer price inflation rose to 2.3 percent year-on-year in March 2019 from 1.5 percent in the previous month, in line with market consensus. This was the highest rate since October last year, mainly due to a surge in prices of food as an outbreak of African swine fever sent the price of pork soaring. Food inflation has always been a problem for China with a particular political sensitivity,
Interest Rates. The benchmark interest rate in China was last recorded at 4.35 percent. It was last cut by 25 basis points in October 2015. On September 27th 2018, the People’s Bank of China left interest rates for open market operations unchanged even after the Federal Reserve s decision to tighten monetary policy.
WITH INFLATION AT 2.3 % AND INTEREST RATES AT 4.35 % CHINA”S REAL INTEREST RATES ARE POSITIVE 2 % MAKING THEM AMONGST THE MOST ATTRACTIVE IN THE WORLD.
STILL, WITH AN ECONOMIC GROWTH RATE OF 6.3 %, MONETARY POLICY CAN BE CONSIDERED TO BE ACCOMMODATIVE AT THESE LEVELS.
Consumption. Retail Sales in China increased 0.91 percent in March of 2019 over the previous month, surprising western commentators and testifying of the success of the economic stimulus implemented by the Government.
Business Confidence. The NBS Manufacturing PMI in China fell unexpectedly to 50.1 in April 2019 from a five-month high of 50.5 in the previous month and missing market expectations of 50.5, as growth slowed for both output (52.1 vs 52.7 in March) and new orders (51.4 vs 51.6).
However, the uptick of the last two months above 50 is a sign that corporations are no longer worried or affected by the Trade War at this stage.
Money. Broad M2 money supply grew 8.6 percent from a year earlier to CNY 188.94 trillion in March 2019, accelerating from a 8 percent increase in February and beating market expectations of 8.2 percent. It was the biggest increase in M2 money supply in 13 months. M1 money supply increased 4.6 percent in March, also faster than 3 percent advance in the previous month.
The recent acceleration in Money Supply bodes well for economic growth ahead and confirms the willingness of the Government to open the credit spigot for Small and Medium size enterprises.
Japan
Growth. The Gross Domestic Product (GDP) in Japan advanced 0.3 percent in the fourth quarter of 2018 over the same quarter of the previous year. The sharp 2018 slowdown in economic growth in Japan has all to do with the Trade War and its impact on global Investments and exports of Industrial goods.
Unemployment. The seasonally adjusted unemployment rate in Japan increased unexpectedly to 2.5 percent in March 2019 from a five-month low of 2.3 percent in the previous month while markets had expected 2.4 percent. Unemployment in Japan is considered to have reached a level below which it is technically impossible to go and therefore to be at full employment.
Inflation. Japan’s consumer price inflation rose to 0.5 percent year-on-year in March 2019 from 0.2 percent in the previous month and in line with market consensus. It was the highest inflation rate since November last year, as cost of both food and transport declined at a softer pace.
March’s number relieved economists and commentators who feared a relapse into deflation in Japan.
Interest Rates. The Bank of Japan left its key short-term interest rate unchanged at -0.1 percent at its April meeting and kept the target for the 10-year government bond yield at around zero percent, as widely expected. The Committee said it intends to keep the current extremely low levels of short-term and long-term interest rates for an extended period of time, at least through around Spring 2020, taking into account uncertainties regarding economic activity and prices including developments in overseas economies and the effects of the scheduled consumption tax hike.
In the country of massive public debt and record current account surpluses, structural deflation has been prevalent for two decades now and interest rates have been kept close to zero for the best part of the last decade.
WITH INTEREST RATES IN NEGATIVE TERRITORY AND INFLATION IN POSITIVE TERRITORY, REAL INTEREST RATES ARE MARGINALLY NEGATIVE. HOWEVER, JAPAN CANNOT AFFORD TO SEE INFLATION GOING SHARPLY INTO NEGATIVE AT THIS STAGE
Consumption. Retail Sales in Japan increased 0.20 percent in March of 2019 over the previous month. Domestic consumption remains Japan’s main problem and sees no acceleration despite strong labor markets. As a result Exports are the main engine of growth of the Japanese economy and they are heavily dependent on the value of the Japanese Yen.
Business Confidence. The Bank of Japan’s Tankan index for big manufacturers’ sentiment fell to a two-year low of 12 in the first quarter 2019 from 19 in the previous three-month period and below market consensus of 14. The positive trend of 2017 was clearly reversed by the Trade Wars and an appreciation of the China currency would be a great positive for Japan’s business confidence.
Money.Money Supply M2 in Japan increased to 1012747 JPY Billion in March from 1010052.60 JPY Billion in February of 2019. However, the decrease of the past two months shows that monetary policy is not sufficiently accommodative and that demand for credit has declined substantially.
The above review of the five largest economic zones of the world representing 61 % of the world GDP shows that the world economy is not in a bad shape altogether.
Most economies are slowing down and only China is giving signs of a widespread revival.
The OECD is expecting the world economy to slow down to a global rate of 2 % this year, the lowest since 2009.
Monetary policies are accommodative in most parts of the world, BUT a collapse in Oil prices could send inflation tanking across the board, making real rates positive almost everywhere.
What the world economy needs is a real agreement for the resolution of the Trade Wars so as to re-ignite investments.
However, this may not be sufficient to avoid a real growth and deflation scare in the second half of the year.
Australia
Australia has been an amazing economic experiment with no recession for the past 28 years. But even it could be caught in the global slowdown.
Anyone thinking that Australia’s economy is an all-conquering model of perfection is likely to get a wake-up call soon. Australia’s central bank never bought the hype, and may be about to acknowledge brewing trouble by cutting rates.
A 28-year run of expansion has had people abroad fawning over life Down Under — Federal Reserve Chairman Jerome Powell among them. For all the superlatives, though, the local central bank considers everything far from rosy.
Notwithstanding, the policy landscape has undergone a big shift the past two months.
The chances that the RBA will deliver an interest-rate cut as soon as next week rose after figures April 24 showed a significant slowing in inflation. As in many developed countries, and quite a few emerging markets, the pace of price increases is consistently below target. Growth isn’t collapsing, but it could do with some perking up.
So why pull the trigger when many others are talking dovish but balking at action? In essence: the effects on consumers of a home-price slump and air pockets resulting from a global downdraft, especially in China.
Taking out insurance against a more pronounced slowdown makes sense.
The prospect of lower borrowing costs presents the RBA with two main risks, both of which are worth considering — and then putting aside. They are that the central bank becomes embroiled in politics a week before the May 18 federal election, and that it revives a property boom many felt couldn’t, and shouldn’t, go on forever.
The politics of Reserve Bank Governor Philip Lowe acknowledging all isn’t entirely well are problematic so close to balloting, especially when there is a very real prospect of the incumbent losing.
Prime Minister Scott Morrison hasn’t publicly tried to nudge the central bank; that could change in coming days.
The RBA has adjusted rates during campaigns a few times, though it tries not to make a habit of it. Borrowing costs were raised during the 2007 campaign, which saw John Howard defeated by Kevin Rudd. In 2013, the bank cut. The first of those two adjustments during the political season caused a fracas; the second less so.
The key point is that life went on, and the RBA’s credibility survived. Arguably, the moves may even have enhanced the central bank’s standing.
Few institutions are revered in Australian life like the RBA, probably reflecting that 28-year run. There’s little mileage in taking on Lowe in public, and Morrison would be ill-advised to attempt it.
The second risk relates to a series of rate cuts. Arguably the biggest chink in Australia’s domestic armor is the slide in home prices. The irony is everyone wanted the residential real-estate market to cool at least a bit. A few cuts from the RBA could breathe some life back into the sector.
That would arrest the drop, but would it bring things back to the way they were?
An RBA research paper published in March found that low rates, with an assist from immigration, fueled the surge in house prices and construction. Sydney home prices climbed about 75 percent in the five years through mid-2017, coinciding with central bank easing.
More recently, Sydney prices are down by more than 10 percent from their peak. Supply struggled to keep pace with demand, which meant that extra capacity hit the market just as prices came off the boil.
While a breather was welcome, the descent is probably too jarring for some. The unemployment rate is low at 5 percent, but consumer spending isn’t firing.
The central bank has held interest rates at the current level since August 2016. Low inflation seems here to stay, so it’s a question of what you do about it. The RBA will probably consider the risks, but move anyway.
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