Global growth is faltering, and gloom hangs over markets and investors. Just how did we get here?
- Patrik Schowitz says while conditions in the US remain stable, the economies of China, Japan and Europe are struggling. US success, however, means the Federal Reserve looks set to continue tightening rates to prevent inflation
A sombre mood has gripped markets in the past few weeks as investors’ risk appetite has crumbled. Growth worries and weakness in technology stocks have stoked extreme turbulence, with most markets dipping significantly. And, this time, even the mighty US equity market has been caught up. It is now down by around 6 per cent from its September peak – nearly identical to the drop for Asian equity indices. Other risky assets, such as corporate bonds, have not fared much better. How did we get here?
The most important driver of global economies and markets, the United States economy, seemed to be firing on all cylinders just months ago. And while the US economy is slowing from an earlier stimulus-driven growth surge, it looks likely to do so only gradually. Furthermore, a US recession looks unlikely, in the near-term at least, which would usually cause a major bear market in risky assets.
There are a whole host of other factors beyond economics to consider, but what has clearly changed is the growth picture outside the US, where the environment has darkened. On the one hand, the outlook for the Chinese economy is a worry. Investors had long ago come to terms with the domestic growth slowdown in China – deciding that authorities had the situation under control. Emerging assets were hurt, but with the growth picture robust elsewhere, global investors were not too spooked.
In recent months, however, growth has also faltered in Europe and Japan. That was not supposed to be part of the popular narrative for 2018, and has further weakened confidence in the global growth outlook. There were plenty of excuses earlier in the year for this unexpected slowdown, from natural catastrophes in Japan to problems with emissions testing in the German car sector. But the truth is that the expected rebound from these one-off factors has been somewhat disappointing and investors are faced with the reality that any rebound is likely to be only middling. Indeed, the global purchasing managers’ index for manufacturing (one of the best indicators of business sentiment) dropped in October, to its lowest level since the first half of 2016.
Escalating trade tensions have only made things worse. They have raised the risk that the Chinese economy slows even more sharply unless more stimulus is applied – although this admittedly is already happening to some extent. And they probably also explain some of the unexpected weakness in other developed economies, or at the very least are holding back their recovery from their respective one-off issues.
At the same time that growth is faltering, global interest rates look set to continue their march upwards. The US Federal Reserve remains the world’s major monetary policymaker, and reacts mostly to the still-strong US economy, where unemployment is low and robust wages threaten inflation. It looks set to keep raising interest rates for some time.
The European Central Bank, too, remains set to at least gradually retreat from its unconventional monetary policy of recent years. While the saying that the Fed has killed all past economic expansions is an exaggeration, it has played a role in the end of many cycles. Investors are worried that the Fed may tighten interest rates more than the global economy can handle, driven by the strong US economy.
Putting all of the above together, in retrospect, it is understandable why markets and investor confidence have faltered. But where do we go from here? The gloom may be overdone: the moderation of economic growth may yet play out benignly, taking the global economy back only to historically average growth rates.
If employment remains robust, the Fed does not overtighten, and the trade dispute ends positively (and there is a chance for some degree of reconciliation at the upcoming G20 talks), then optimism should eventually return to markets. Even then, that case would probably take several months to play out, during which time risk asset markets are likely to struggle.
Patrik Schowitz is a global multi-asset strategist at J.P. Morgan Asset Management