Global expansion may have reached a self-sustaining velocity


Bob Baur

Clear signs that global expansion is on track

The global economic recovery that began in early 2016 has reached a self-sustaining velocity. Momentum is likely peaking, but solid growth should persist well into 2018.  The evidence pointing to this is compelling, strong industrial production, robust growth, and improved capital spending. The case is further strengthened when we consider that business and consumer confidence is surging, in some cases to record levels, and stock market internals such as low interest rates, rebounding profits, fading caution and recent relative performance of small cap and value stocks to large cap growth stocks also confirm the reflation.

Bank indices are offering better returns than the overall market. Mildly rising interest rates also suggest that investors appreciate some of the more recent worries such as risks of deflation, political turmoil in Europe, or a China hard landing have fallen significantly.

Of the 45 countries tracked by Organisation of Economic Cooperation and Development, all are growing and many are accelerating. With the global financial crisis nearly a decade in the rear-view mirror, the dread, fear, and caution it generated is starting to fade. So, even if structural forces pressure long-term yields lower, cyclical forces of solid growth momentum should push rates higher in the near-term.

In particular, the Eurozone and Japan are surging, with positive news from the US and China

Economic sentiment in the Eurozone is approaching a 17-year high as confidence improved in every sector and country. Inflation in Italy stays modest at 1.12% over the prior year in September and unemployment is falling and job gains are healthy.

Although growth in Japan is shy of the 2.5% annualized pace of the second-quarter, Prime Minister Abe is confident enough to call a snap election for October 22nd. Spurred on no doubt by a 15 year high in labor force participation rate is the highest in nearly fifteen years, record corporate profits and investment is picking up.

The U.S. is remaining consistently positive. Confidence is high, job growth is robust, and inflation is subdued.  Over in China manufacturing and service businesses are improving and although growth is not accelerating, but no near-term hard landing is anywhere in sight.

Robust growth and less accommodation

The world expansion rolls on and central banks are contemplating reducing monetary ease. With higher oil prices, solid global growth, and fading investor caution, long-term sovereign bond yields should work higher into year-end.

Asset allocation: return to reflation

Cyclical securities rebounded in September because investors judged the global upturn to be self-sustaining. Robust economic conditions suggest there’s more rally ahead. However, rising interest rates or inflation concerns could trigger a correction from high valuations.

What happens when governments are supplying fiscal stimulus to already robust economies rather than during recessions or tough times

We may soon find out.. The U.S. Congress will soon discuss a tax bill with large business tax cuts. Japanese officials suggest future tax hike proceeds be used to support education. The German election combined with French President Macron’s plans for a more integrated Europe may result in looser budget constraints. Cuts to required reserves in China are also a stimulus. If reflation doesn’t ignite on its own, fiscal stimulus may do it, perhaps even bringing concerns of overheating.

Looking ahead

The global economy is likely at peak growth momentum now. Any deceleration into year-end or beyond coupled with higher long-term rates could precipitate a correction. So, the potential for a longer rally is still there, but interim risk is rising. Those of the faint of heart might want to use this rally to take a few more chips off the table.

By Bob Baur, Chief Global Economist

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