Economic Facts – Tuesday 28th January 2020

General

General: For 2020, the synchronous easing of trade tensions and monetary policy will be a key theme. Though U.S.-China trade will remain a factor in 2020, the current sentiment is positive. 20 central banks have eased monetary policy over the past 12 months and Morgan Stanley economists expect more easing, with the global weighted average policy rate reaching a seven-year low by March 2020.

General:  On the positive side, stabilizing growth elsewhere in the world should lift exports and business investment, which are currently at very low levels. Putting this together.

General: High valuations in many markets, disparate regional cycles and a recovery that relies on continued progress in trade negotiations. “We think that 2020 will be about an uneven global recovery colliding with uneven valuations, broadly speaking, U.S. risk assets are already fairly valued, but there are opportunities above the index, and in other regions and asset classes around the world”. Here are seven key themes for 2020.

Global Equities: It looks like we’re in a new cyclical bull market (based on a familiar and reliable global equity market breadth signal). This chart and a few other global equity market breadth indicators helped pick the big breakout late last year. It’s quite likely that if the new cyclical bull market does get derailed somehow, that we see early warning signs show up in this chart. So, this will be a key one to watch for risk asset allocations.

Commodities: Commodities (at an asset class level) have also seen a familiar market breadth pattern emerge, which points to a cyclical bull market (lines up with relatively light positioning, cheap valuations, and a prospective better macro backdrop). The outlook across the individual commodities that make up this index is a bit more nuanced, but the aggregate/asset class view looks straightforward based on the sum of evidence from our indicator set.

Energy: OPEC’s spare capacity is low, and any rebound in demand could challenge supply-side constraints. Moreover, there’s always the risk of an unplanned outage to nudge the oil market, according to BCA Research.

FX Volatility: One key piece of the puzzle for commodities is the US dollar, and while I continue to maintain a bearish bias there, one thing I am very mindful of is the crunch in FX volatility. Typically crunches in volatility like this tend to be resolved in a violent fashion: that is, it could be a harbinger of a large/rapid move (agnostic of direction). So, will 2020 bring a return of volatility for the US dollar.

The Virus: The virus causes pneumonia. Those who have fallen ill are reported to suffer coughs, fever and breathing difficulties. In severe cases there can be organ failure. As this is viral pneumonia, antibiotics are of no use. The antiviral drugs we have against flu will not work. If people are admitted to hospital, they may get support for their lungs and other organs as well as fluids. Recovery will depend on the strength of their immune system. Many of those who have died are known to have been already in poor health. A 2004 analysis determined that the SARS crisis cost the world economy a total of about $40 billion.

 

America

United States: CPI volatility is low relative to asset price volatility. According to Morgan Stanley, dovish Fed policy chasing higher inflation is more likely to result in higher asset price inflation before we get to higher consumer inflation. And that could pose a risk to financial stability.

United States: The growth in revolving consumer credit is falling behind the increase in wages. According to TS Lombard, this indicator typically spikes heading into a recession or periods of perceived economic stress.

The United States: The January manufacturing report from the NY Fed (Empire Manufacturing) showed some hopeful signs. Indexes assessing the six-month outlook suggested that optimism about future conditions remained restrained. The index for future business conditions edged down three points to 23.6. The index for future shipments climbed five points to 32.7, indicating that firms expect shipments to increase in the months ahead, and employment and hours worked are expected to grow modestly. The capital expenditures index held steady at 25.3, and the technology spending index moved down five points to 22.6.

United States: The US Census Bureau showed housing starts rising sharply in December. The seasonally adjusted annual rate for housing starts reached 1.61 million last month, its highest point since December 2006. The positive data suggests continued recovery in the US housing market amid low mortgage rates, historically low unemployment levels, and robust consumer confidence.

United States: The Bloomberg US Consumer Comfort Index is at the highest level in two decades Confidence among U.S. consumers climbed to the highest level in five months as Americans grew more optimistic about the economy and their personal finances Bloomberg’s index of consumer comfort rose 1.6 points, the most since June, to 63.9 in the week ended Dec. 29, according to a report Thursday. The gauge for the state of the economy also hit a five-month high and the reading for personal finances increased to the best level in three months.

United States: While a surge in these behemoths is good news for anyone simply chasing the index higher, to some strategists it’s a sign investor have lost their appetite for risk amid fears the economic cycle is set to slow. Thanks to innovation and market dominance — the bull case goes — these tech giants can deliver profit growth regardless of what happens in the economy.

 

Europe

The Eurozone: Growth in the euro area for this year was revised down by 0.1 percentage points to 1.3%, according to the IMF. But that projection reflects a pickup from last year’s 1.2% estimate, which the organization attributed to an expected improvement in external demand. These are the IMF’s growth forecasts for major European economies this year: Germany: 1.1%France: 1.3%Italy: 0.5%Spain: 1.6%.

The Eurozone: Analysts have taken a dim view of the region’s investor prospects in the presence of rising global trade barriers and limited relief from monetary-policy stimulus, with political and structural factors also to blame. Cyprus, Greece, Portugal and Ireland have continued their trend improvements as the effects of their debt crises continue to fade.

The Eurozone: European trade and industry have weakened, slowing growth. Following global trends, trade and manufacturing in Europe have weakened considerably. This weakness is primarily driven by machinery and transport equipment—sectors that are particularly relevant for Europe. As a result, economic activity in Europe has slowed, especially in advanced economies. Emerging European economies outside of Russia and Turkey were a bright spot, with growth remaining strong.

The Eurozone: Some signs of spillovers, but still relatively limited. The weakening trade and manufacturing—along with subdued business confidence and elevated trade uncertainty—have started to spill over into investment, especially in many advanced European countries. While the services sector has been relatively buoyant, it too has started to soften. Private consumption, however, has stayed relatively robust.

The Eurozone: Labour markets hold the key to the resilience of services and consumption. If employment and wage growth remain robust, consumption spending and hence the demand for services will remain buoyant. Labour markets in Europe are still strong—unemployment rates are at or below pre-crisis levels and wage growth has generally held up. However, signs of a slowdown are also emerging in labour markets. For example, job openings—a measure of labour demand—are not only falling in the manufacturing sector, but vacancy growth for the overall economy has also slowed since the beginning of the year.

The Eurozone: The price of labour—namely wages—is rising at a robust pace, especially in the European Union’s newer member states. Yet, surprisingly, inflation has barely risen. The above chart shows that the link between wages and prices in Europe has weakened considerably in the decade since the global financial crisis. More precisely, the impact of wage growth on core inflation has been only two-thirds as strong as in the period before the crisis. shows that the link between wages and prices in Europe has weakened considerably in the decade since the global financial crisis. More precisely, the impact of wage growth on core inflation has been only two-thirds as strong as in the period before the crisis.

 

China

China: The Wuhan virus continues to spread. It’s worth noting that China’s consumption took a hit during the SARS outbreak in 2003.

China: The renminbi declined for the second day (chart below), and China’s stock market slumped (second chart) on worries about the Wuhan coronavirus. The businesses most directly affected, so far, have been transport and tourism-related industries with airlines cancelling flights, hotels waiving cancellation charges and travellers staying home during what is normally one of the busiest travel times of the year in the mainland. Some three billion trips were expected within China this year during the 40-day Lunar New Year holiday travel period.

China: Although local state-owned enterprises (SOEs) are deleveraging, SOEs owned by the central government remain highly leveraged China is the biggest emerging economy and the World Bank suggests that the “debt-fuelled” investment boom there could result in non-performing loans and a corporate debt crisis. Given the size of China’s economy, spillovers to other emerging economies could be “significant”.

China: Analysts remain concerned about China’s rising nonperforming loans (NPLs). Amid rising defaults and tighter liquidity for Chinese privately-owned enterprises, the nation’s banks are letting some companies fail Defaults in China’s onshore corporate bond market hit a record in 2019 and troubles have continued in the offshore market as well this year.

China: Finally, this chart shows Chinese property price growth vs China A-shares. It’s a useful chart for China watchers and global investors in general, but it’s of interest now because property price growth is rolling over, and that could be good news for China A-shares. Because the marginal speculative investment dollar in China is basically trapped in the country, you tend to see this succession of chasing one hot asset after another. Thus, we could start to see a rotation effect between property and stocks in China, and that (along with cheap valuations, easier monetary policy, better global growth, and a trade deal/truce) could drive a potentially explosive new bull market in China A-shares.

China: The Bloomberg Li Keqiang Index rose in November, driven largely by an improvement in electricity output Despite calls for a stimulus, the People’s Bank of China is not budging for the time being. Instead, the authorities are looking at more rational allocation of resources and indirect incentives, such as injecting extra liquidity by loosening banks’ reserve requirements and offering tax cuts, at the expense of government revenue.

China: Exports surprised to the upside. Imports were robust as well. He strong rebound in exports could be partly due to seasonal factors related to the Lunar New Year (that falls on 25 January in 2020, nearly two weeks earlier than in 2019) and a low base-year effect. However, we believe it also reflects some real improvement in global demand, as some indicators outside of China are also showing signs of a recovery.

 

Emerging Markets

Emerging Markets: Easier monetary policy in EM is expected to boost economic activity. A big part of the 2020 recovery thesis is the global monetary policy pivot. Not many have noticed, but EM central banks have been particularly aggressive in easing policy (and by the way, they have the most traditional policy ammunition available). Given some of the cycle indicators have already begun to stabilize for EM. I have a strong degree of confidence that we will see a cyclical upturn across emerging economies in the coming months and quarters.

 

Australia

Australia: Directors are now markedly less confident, with the overall DSI index having moved deeper into negative territory, sliding from minus 16.9 in the first half of 2019 to minus 21.1 in the second, the weakest reading since September 2016. Likewise, roughly 49 per cent of respondents judge the current health of the Australian economy as weak versus just 11 per cent who think it strong (the remaining 40 per cent think the economy is OK). Views become even more cautious when directors are asked about their assessment for the next 12 months.

The consumer: The constant terrible news since October about the bushfires, along with the smoke in cities is likely weighing further on the national psyche adding to weakness in consumer spending as Australians feel less motivated to spend when their fellow Australians are suffering. The hit to household spending power from higher prices for food and a likely rise in insurance premiums flowing from the fires will only accentuate this.

Australia has: (a) the world’s second-most indebted consumers, (b) anaemic wage growth (c) falling credit (d) a crash in housing construction. The government’s economic plan seems to be to grow housing credit by: Not spending so that the RBA needs to cut interest rates further and Letting first home buyers borrow up to 95%. I’m very doubtful it will work.

Australia: Signs of recovery in the residential property market have been emerging for some time, with sentiment turning around convincingly in May. Since then, auction clearance rates have picked up sharply, prices have been rising strongly in Sydney and Melbourne and housing finance is starting to pick up. “The improvement in the residential property market seems set to continue.”

Australia: Great news about unemployment – it has been improving! In response the stock market immediately fell. this result is not the best result imaginable, but it is a lot better than market watchers feared. A stronger labour market means less need for the RBA to step in. The stock market was predicting a 58 per cent chance of a rate cut at the next RBA board meeting. But by Thursday that had slumped to 28 per cent.

State household demand

 

Australia: The breakdown of household demand by state shows that the stable base of 3% p.a. growth in the nation’s two biggest states (NSW and Victoria) has now fallen to be only 1% p.a. Given Melbourne and Sydney property prices saw the largest declines nationally, it should not be surprising that there was a considerable step down in household demand. Without tailwinds from the housing sector it is hard to envisage consumption running consistently at 3% p.a., as this is well ahead of what households have been receiving in wage gains – averaging a little over 2% for the past four years.

Disposable income and consumption

Australia: The most recent GDP results also showed that disposable income increased 5.1% over the year, the largest increase since 2014, due to recent tax cuts implemented by the government. Unfortunately for the RBA this didn’t bring with it an increase in spending.

Household savings: The Chief Economist of the Australian Bureau of Statistics (ABS) noted that this was due to discretionary spending slowing, causing the savings rate to rise considerably. While the wealth effect has obviously not yet flowed through to the economy (savings are rising, and consumption is slowing) the lag between house prices and consumption identified above does imply that we should see this begin to improve early next year. If we add on top of this improved disposable income from tax cuts, it is at least foreseeable that households will begin to increase their demand for goods in 2020.

Australia: A month ago the market was pricing in another rate cut to 0.5% to occur by May; now it thinks it will happen only by July. It would seem the market believes the government will need to respond to the bushfires with increased spending and that this may offset the urgency for another interest rate cut – and yet another rate cut still remains more likely than not.

Australia: The most important chart for 2020 for equity investors comes courtesy of the bond market. Australia’s 5-year breakeven rate – the difference between the yield of a nominal Australian government bond and an Australian inflation-linked government bond of the same maturity (in this case, 5 years) – has been rising since hitting an historic low in August of only 1.02%. Today, the 5-year breakeven rate stands at 1.30%, suggesting that RBA interest rate cuts are having some impact on investor expectations of inflation. Whilst still 0.70% below the lower range of the RBA’s inflation target, the RBA Board should be encouraged that the decline in inflation expectations has been addressed to some extent.

 

 

 

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