Investment Comment August 2019
5th August 2019
Will monetary easing counter global headwinds?
The downturn in the global manufacturing sector extended for a third consecutive month in July, with output and new orders declining further. Conditions in many economies remained soft and international trade volumes continued to contract. The global manufacturing Purchasing Managers Index (PMI) recorded a reading of 49.3, a slight decline from 49.4 in June (a reading of less than 50.0 indicates contraction). Nineteen of the thirty national PMI recordings available for July recorded downturns in manufacturing activity.
Forecasts continue to predict a slowing of global growth, consistent with late cycle economies, but signs of recession remain elusive. The International Monetary Fund's (IMF) World Economic Outlook report highlighted global market uncertainty, driven by a potentially adverse trade agreement between the US and China, along with the divergence in views on an appropriate withdrawal agreement between the UK and the EU. The IMF expects global economic growth of +3.2% and +3.5% in 2019 and 2020 respectively, representing its fourth downgrade since last October.
Upward revisions were reported for the US and the euro area to +2.6% and+1.3% for 2019 respectively, but expectations for 2020 remain unchanged. The IMF further cut its growth forecast for emerging markets to +4.1% in 2019 and +4.7% in 2020 and expects Chinese GDP growth to decelerate to +6.2% and +6.0% in 2019 and 2020. The Indian economy received relatively stronger downward revisions of-0.3 percentage points for both 2019 and 2020, although growth expectations remain robust at +7.0% and +7.2% respectively. The IMF does not see any sign of a recession but does highlight "significant downside risk" for global expansion going forward.
US manufacturing saw a small improvement in output growth in July, but muted demand is dampening overall expansion. The manufacturing PMI remained indicative of growth but posted a marginally lower figure of 50.4 on the month compared to 50.6 in June. GDP growth in the second quarter recorded an expansion of +2.1% year-on year, slowing from +3.1% year-on-year in the first quarter of 2019. Labour market data suggest a further tightening of the US job market, remaining resilient to the economy shifting into a lower gear.
The US Federal Reserve (Fed) reduced its benchmark overnight rate from 2.5% to 2.25%, for the first time since 2008. Fed Chairman Jerome Powell explained that the cut should be perceived as a "mid-cycle adjustment" to policy rather than the beginning of a "lengthy cutting cycle" as the Fed attempts to "insure" against downside risks to the economy as a result of trade tensions between the US and China. In this regard, President Trump indicated that the US will start, on September 1, charging an additional tariff of 10% on the remaining $300bn of goods and products imported from China. President Trump justified the decision by citing China's inability to follow through on its pledges to buy more farm products from the US. Consensus suggests the Fed will be more data-dependent going forward and will closely monitor further developments in the economy and act accordingly.
In the UK, new factory orders fell at their fastest pace since 2008/09 in the three months to July and both consumer spending and house prices declined. Commentators point to signs that consumer and business confidence is being increasingly impacted by protracted uncertainty over Brexit. However, this contrasts with economic data released by the Office for National Statistics, which suggest the economy expanded more than expected year-on-year in May, by 1.5%, exceeding forecasts of 1.3%.
In the eurozone, consumer prices increased slightly more than anticipated in June but remain below the 2% target that policymakers are seeking. Eurostat reported that prices increased by 1.3% year-on-year in June, up +0.2%, which beat the consensus forecast of a +0.1% increase. However, manufacturing activity contracted at an accelerated rate, with the eurozone manufacturing PMI producing a reading of 46.5 in July, down from 47.6 in June.
Soft demand in Japan continues to drag on the manufacturing sector. The Japanese manufacturing PMI produced a reading of 49.4 in July, signalling a third successive monthly deterioration in the manufacturing business environment. Core inflation also slowed to its weakest in two years in June. However, the nation's budget for the next fiscal year will earmark 4.4 trillion yen (c.£33bn) as a means to boost demand and enhance science and technology as part of Prime Minister Shinzo Abe's growth strategy.
At 6.2% year-on-year in the second quarter, Chinese GDP growth slowed to its weakest pace in 27 years, as demand at home and abroad faltered in the face of mounting US trade pressures but remains strong relative to global expansion. China's manufacturing sector was broadly stable in July, with output little changed since the June decline, and overall new orders marginally improved. Subdued demand, however, prompted firms to lower their workforce, whilst inventories of both inputs and finished goods declined. Despite the market expecting more support, the Chinese central bank kept its main policy rates unchanged. It is expected that monetary policy will remain sensible and that growth stimulus will come from fiscal policy reforms.
Credit and GDP growth in India continued their gradual slowdown. However, growth in the nation's manufacturing industry was sustained in July. Rising from 52.1 in June to 52.5, the manufacturing PMI continued to show growth consistency in the sector. New export orders also continued to improve but with a noticeable slowdown. Slight signs of strength are also prevalent in the rural economy, with rural wages continuing their upward trend.
Global trade continues to present the most material risk to financial markets. With major central banks turning data dependent and acting on slowing growth via monetary easing, we reiterate our view that more dovish central banks will support equity markets and potentially mitigate downside risk in the near term. We continue to advise our clients on the importance of holding a well-diversified portfolio and taking a long-term view on their investment performance.