Bob Baur

Recovery from the pandemic recession is in progress around the world. It’s well underway in China and parts of Southeast Asia and getting a good start in the Eurozone and United States, according to Principal Global Investors Chief Global Economist Dr Bob Baur.

According to Dr Baur, the fast, sharp economic recoil from the pandemic plunge is likely over, although several countries are continuing to experience high or fast rising daily cases, especially India, much of Latin America, Indonesia and the Philippines.

US rebound dampened

The US economy had advanced in May and June, following the record collapse in March and April. However, concerns about new cases have slowed this recovery.

“We’d been expecting a V-shaped bounce that would last perhaps two to four months as U.S. businesses reopened and people started back to work. But widespread concern about the pickup in daily new U.S. COVID-19 cases since late June dampened the rebound’s vigour, likely limiting the V to two months.  The good news is that daily new U.S. COVID-19 cases may have peaked July 23 as the seven-day moving average has been falling since then, down to 61,964 on August 1. If that does prove to be the peak, the U.S. recovery will likely stay on track but at a more muted pace than in May and June,” said Dr Baur.

Dr Baur cautioned that a full recovery from the recession may be “challenging and lengthy”. “Millions of workers are still on furlough or permanent layoff. Many small businesses won’t reopen, especially in leisure and hospitality, with even large chains facing huge losses. The COVID-19 virus is proving resilient and lasting and may require major changes as we learn to live with it. We’re optimistic that the revival from the cavernous losses of March and April will last through 2021, but it will likely be at a more measured pace than the bounce since early May. As a result, the U.S. economy may not exceed its prior peaks in either GDP or employment until sometime in 2022,” he said.

Dynamic revival in China

Dr Baur said that industrial output had returned to the prior year’s level in June, and industrial profits showed a second month of growth at 11.5% over the prior year. Official purchasing manager indices (PMI) from the National Bureau of Statistics for manufacturing edged up to 51.1 in July up from a February plunge to 35.7, the worst on record. The non-manufacturing PMI slid 0.2 to a still-strong 54.2, which put the composite PMI at 54.1, the second best since mid-2018.

Real estate and stocks also performed well with construction PMI a robust 60.5 and year-to-date property investment up 1.9% from the same period last year. Chinese stock indices were world leaders in July with the Shenzhen Composite Index up a healthy 14.2%.

“Households in China stay more restrained, likely from a lingering fear of COVID-19 activity. China is experiencing a mild flareup of new cases in the last few days that may keep consumer spending from normalizing for a while. June retail sales were still 1.3% below June 2019. Vehicle sales, though, have been very strong. China was the first economy to exit the pandemic recession and its revival has been dynamic. We expect it to continue,” said Dr Baur.

Recovery in greater Europe is underway

The Eurozone composite PMI, at 54.8 in July was the best since mid-2018. Eurozone consumer sentiment is still low but rising. After a nearly incomprehensible 40.3% annualised plunge in second quarter Eurozone GDP, Dr Baur expected the upsurge in the third quarter to reach well into double digits.

“Several things are helping in the Eurozone. New cases of COVID-19 are staying low and the end of the lockdown seems to have gone fairly smoothly. The robust rebound in China has given Eurozone businesses a lift in confidence given the area’s healthy exports to China. Further, wage subsidization plans have kept unemployment from rising very much.

“Perhaps most importantly, the political leadership of the European Union (EU) has created an economic recovery plan that encompasses what may be the first step toward a fiscal union. The Recovery and Resilience Fund is a €750 billion addition to the EU budget. The money will be borrowed in the name of the EU and the funds will be available for loans and grants to member countries. The purpose of the Fund is to finance investment projects that will raise a country’s long-term growth potential. It’s a real step toward coordinated fiscal policy. This Fund establishes the principle that the EU can borrow funds and repay the debt with taxes it collects from member countries. Euro-area recovery should continue,” explained Dr Baur.

Extended difficulties in Japan

As the number of daily new COVID-19 cases in Japan is spiking, Dr Baur predicted a “sluggish and prolonged” recovery for Japan.

“The pandemic extended the difficulties the Japanese economy was having trying to recover from an October hike in the value-added tax. Now, however, just as data began to improve a bit, the number of daily new COVID-19 cases is spiking, reaching a new high of 1464 on August 1 according to Worldometer,” said Dr Baur.

Read the full Economic Insights for the month of August here.

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Bob Baur

COVID-19 has severely disrupted the world’s economy, plunging it into the worst recession since 1930 and putting an end to the longest economic uptrend in history. According to the National Bureau of Economic Research (NBER), the arbiter of U.S. business cycle dates, February was the peak of the last expansion, ending the 128-month period of expansion.

Dr Bob Baur notes that while many are calling for a prolonged period of economic stagnation, economic data suggests the opposite, with a recovery already under way in much of the world. While NBER is yet to put a date on the end of this recession, it is likely that despite it being the worst since 1930, it may well be the shortest.

First to emerge from the lockdown, China leads the way to recovery

“China was the first country to emerge from the COVID-19 lockdown and data from its government notes economic improvement in March from the collapse in January and February.”

Dr Baur indicates that this economic improvement bodes well for the rest of the world, with industrial output and consumer spending among the data improving:

“Industrial output for those worst two months combined was down 13.5% below the prior year. Production surged in March and surpassed the prior year in April, up 3.9%; further progress was made in May.

“Purchasing manager indices (PMIs) from manufacturing business surveys improved from May and showed faster expansion. According to the Chinese government, industry is mostly back to normal and expecting output in June to exceed May’s annual gain.

“Consumer spending is still somewhat restrained from lingering fear of infection with retail sales disintegrating in January and February, off a combined 23.7% from the same period in 2019. Sales recovered in May but were still down 2.8% from the prior year. Still, demand seems to be improving overall.”

The U.S. economy rushed higher in May as business reopened

“The huge May pop following the April economic collapse was like taking the express elevator back to the ground floor from the sub-subbasement”, said Bob Baur on the V-shaped upwelling after a record contraction.

“By September, the early reopening energy will have dissipated, and the recovery turn more gradual. We expect vigorous third-quarter GDP growth near 10% annualized but followed by a more prolonged recovery with GDP and employment not likely to reach their prior peaks until 2022.

“Regional manufacturing PMIs leapt to near breakeven or more in New York, Philadelphia, Richmond, Kansas City and Dallas, most well above expectations.

“May retail sales sky-rocketed 17.7% over April as consensus forecast only an 8.4% gain.

“May payrolls climbed a monster 2.5 million jobs versus pre-report guesses of a 7.5 million job loss. June payrolls continued the gusher with a record gain of 4.8 million new jobs, 1.6 million above average projections.”

Stay optimistic for now

“The continued revival of world growth should keep the equity uptrend intact at least for a while. There’s a lot of uncertainty around the strength of the rebound into next year and the potential for a second wave of virus activity.

“Looking further ahead, stock valuations as well as bond prices are very high, signs that long-term financial returns may be far less than exciting. The best potential for robust long-term equity profits is a rotation into value and cyclical stocks, a reverse of the investment climate of the last decade.

“For now, though, the recovery seems on track and we’d stay fully invested commensurate with one’s tolerance for risk. Stay optimistic for now.”

By Bob Baur, Chief Global Economist

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Bob Baur

A unique recession

 “This recession is unique in that it’s deeper, with a much bigger loss of GDP: We’re not visiting restaurants, gyms, or airports less frequently … we’re not going at all!

“The recession will be selective in who it hurts: this is a small business recession concentrated in service industries. Manufacturers are holding up better. Some large companies are hiring big numbers of people.

“This recession resulted from a desire to constrain a medical danger by closing businesses and pushing people to avoid crowds. Since the cause was unique, it’s likely the downturn and aftermath will be quite different.”

Spending down and recovery slow in a reopened China 

“The reopening of the global economy will likely follow the shape of activity in China. Businesses there have restarted operations but are not necessarily at capacity.

“Leaders at Caterpillar noted that all of its facilities in China are operating. Traffic monitors show rush hour traffic is mostly back to normal. Official April business surveys showed further mild expansion and a modest improvement from March. The National People’s Congress is scheduled for May 22, a vote of confidence in mitigation.

“While businesses have mostly restarted, China’s households stay cautious. Restaurants are open, but seats are empty. Vehicle sales bounced off the bottom but are well below normal.

“Households in the U.S. and Europe will surely mirror this wary attitude even as activity picks up.”

The worst is behind us, but expect stocks to relapse in June

“Much of the eventual improved growth and virus news is already priced into markets. We are now just past the worst phase of recession. As growth picks up in summer and fall, equities should be able to move modestly higher.

“Because so much future growth and uptrend potential is priced in, we expect a period of relapse and consolidation through June. Even though stocks often retest recent bear market lows after an initial upsurge, the S&P 500 Index trough of 2200 seems well out of reach given the enormity of the Fed’s backstop.

“Earnings pessimism should return at some point and we can envision a relapse to 2600 or below, a likely good entry point for those underweight stocks.”

What to do with your investments?

“For one or two months, we like large cap growth and tech stocks; those past leaders should continue to outperform as markets consolidate and thrash about before the next move higher.

“On a six-to nine-month basis, we like stocks that do well when growth accelerates: small caps and sectors like energy, materials, consumer discretionary, financials.

“With the U.S. dollar likely to weaken, we prefer select emerging market stocks over those in developed countries outside the U.S.

“For bonds, the Fed and other central banks will keep short term rates at super low levels for a long time, surely through most of next year. Even long-term U.S., German, and Japanese sovereign bond yields will stay low with massive central bank bond purchases. However, those long-term yields could be under modest upward pressure later this year as growth improves. That steeper yield curve would be good for financial stocks.

“All these suggestions are tactical, short-term in nature. This is not a time to make long-term investment decisions. It’s possible that equity returns, even over several years, may not be very rewarding.”

By Bob Baur, Chief Global Economist 

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Bob Baur

Principal Global Investors has released its Economic Insights for the month of September.

Writing in the note to investors, Chief Global Economist, Dr Bob Baur, said that the world economic slowdown refuses to fade, however, economic momentum feels better.

The tug-of-war

“For some months, the world economy has seemed at a crossroads. With industrial activity stagnating, confidence downcast, trade tension lofty, profits flat, and stock markets under pressure, the gloomy stage feels set for recession,” wrote Dr Baur.

“And yet. Pulling the economy back from the brink were robust household spending, solid labour markets, healthy wage growth, super-low long-term interest rates, and easier central bank policy. The global economy struggles to find a bottom to this long-running slowdown.”

Is China stabilising?

While some headlines describe the recent August data as disappointing, Dr Baur pointed out that there’s been monthly sequential progress since the low earlier in the year:

“Industrial production had a nice 0.4% or so bounce in August from July, even though year-over-year growth fell. Fixed investment was also up sequentially the last few months.

“Business surveys have ticked higher with manufacturing now showing expansion. Further, Chinese data on industrial profits, exports, nominal gross domestic product (GDP), producer prices, crude steel, and cement output, among other series, haven’t declined as severely as those of the industrial recession of 2015. That’s also true of private surveys of United States company sales to China.”

Will the US enter a recession?

“Geopolitical risks are large and well-known. But the biggest recession risk we see is a deterioration in corporate profits. The portion of chief executives or financial officers who expect a recession in the next year has stayed above 60% since January. For some time, we chalked all that up to trade tensions, tariffs, and related uncertainties. However, recent downward revisions to U.S. corporate profits suggest that margins have been shrinking. Business sentiment is closely tied to profit growth. Overall profits have been mostly flat for several quarters and are below their 2018 peak,” said Dr Baur.

China and trade tensions

“When China joined the World Trade Organization in 2001, the country added hundreds of millions of low-cost workers to the world labour supply. U.S. companies moved production facilities to utilise those workers and export their lower-cost goods to the West,” said Dr Baur.

“Chinese wages grew very fast as more global companies set up shop there. Chinese workers gradually became less competitive. Then slow wage growth and the popular narrative of stagnant income created a political backlash that’s still playing out in the U.S. and greater Europe. Today’s trade tensions are a consequence of that backlash.”

Dr Baur said he expects developing momentum in China and the U.S. to broaden into a modest world upturn into 2020.

“With companies under profit pressure and uncertainty still high, any revival that gets underway could run out of steam late next year or early in 2021. That might set the stage for a mild recession. The long rise in corporate debt, propelled by super-low interest rates, could bring credit strains and worsen a nascent downturn. For now, though, let’s enjoy the recovery and see what happens.”

The post Headlines still worried, momentum a little better appeared first on AdviserVoice.

Bob Baur

After major indices on US stock markets hit all-time highs in July, the plunge in bond yields is bringing increasingly agitated warnings about worsening growth and recession.

Writing in a blog, Principal Global Investors Chief Global Economist, Dr Bob Baur said, “this agonising may simply mean that we are in the worst of the slowdown. We think and hope the odds favour us being in the dark before the dawn”.

A storm before the calm 

“The escalation of trade conflicts and tariffs in August did worsen sentiment and likely delayed further recovery. With uncertainty high, it’s natural for business leaders to shelve long-term capital spending decisions until the trade dustup clears.

“Central banks are in a tizzy, too. More than 30 have sliced interest rates this year, from Botswana to New Zealand to China, with more cuts coming.

“Under pressure from negative interest rates, bank stock indices in Europe and Japan are plumbing 20-year lows while a robust U.S. dollar is putting pressure on Argentina and other emerging markets.

“Still, an encouraging Presidential tweet or lack of Chinese retaliation can turn a vicious down day into a surging rally.”

Signs of progress

Dr Baur noted that there have been several new signs of progress over the past month.

“Bank loans are rising. Initial claims for jobless benefits show no negative trade impact. Layoff announcements are minimal. Wage gains are still accelerating.

“Second quarter corporate profits jumped 5.1% and are now up 2.2% over the prior year, no longer a recession indicator. Consumer spending is robust, up 2.7% over last year and appears on track for a strong gain this quarter. Gas prices are falling, helping budgets. The household saving rate is 7.7%; balance sheets are in fine shape.”

In Europe, where the business confidence shock was the worst, the outlook is modestly positive, according to Dr Baur: “The European Economic Sentiment Indicator rose a few ticks, contrary to expectations.

In China the outlook is also looking up: “Borrowing rates were lowered for small businesses and more fiscal stimulus is likely coming, and global companies most exposed to China are outperforming. Local Chinese equity indices had better returns in August than major U.S. indices.”

Could we talk ourselves into a recession?

“A further downward spiral in sentiment would be trouble. It could start a self-fulfilling cycle of layoffs, puny wage growth, anaemic consumer spending, and lousy profits.”

However, Dr Baur thinks that it’s too early to plan for recession within the next year. “The record- long U.S. expansion still has legs (see: a healthy labour market and vigorous wage gains supporting consumers).

“China is adding to its fiscal and monetary stimulus. Central banks stay very accommodating. Financial conditions have eased. There is little stress in credit markets.

“We expect a mild pickup in world growth in the fourth quarter”.

Looking ahead

“The most disturbing feature of the year to date has been the relentless nose-dive in long-term safe- haven bond yields. From a peak of 2.8% last January, yields on 10-year U.S. treasury bonds ended August at 1.5%.”

The fear generated by the plunge won’t vanish easily according to Dr Baur, who anticipates “Central banks will lower rates further. The Fed will cut the funds rate by at least 0.25% in September…. The European Central Bank will drop its official rate more deeply into negative territory and probably restart bond purchases in September.

“Even if inflation does inch higher, which we expect as the slowdown fades, central banks will stay accommodative for a long time.”

“Long-bond yields are too low even for the current environment, but they will likely not advance without clear evidence of a pickup in growth.

“With any trade resolution unlikely soon, the erratic markets of August may persist into October… If that’s the case, U.S. treasury yields could retest the lows of 2012 and 2016. Beyond that, government bond yields are surely tracing out a trough that will hold into 2021.

“Regarding equities, most world stock indices are ahead for the year, thanks to the turnaround in central bank intentions and the collapse in interest rates.”

However, volatility “will likely continue until a definite recovery of world growth becomes evident sometime in the fourth quarter”.

“As trade tension and growth worries have intensified, investors rotated into defensive sectors taking them to valuation extremes relative to the rest of the market.

“We’ve advised caution for many months and still believe it’s the right touch. Without a recession, it’s hard to imagine U.S. treasury yields going much lower from here.”

The post Is recession already baked in? appeared first on AdviserVoice.

Bob Baur

“Intensified trade tensions and disappointment with interest rate cuts by the Fed could provoke a relapse in equity markets.”

That’s the view of Principal Global Investors Chief Global Economist, Dr Bob Baur. Writing in his July monthly economic notes, Dr Baur argued that even if world growth picks up as expected, good financial returns might remain very hard to find over the longer-term.

Trump’s tariffs cause ongoing uncertainty, but end of the Asian downturn may be ahead

“Where to find good financial returns depends on the economic environment within which markets will function. The growth slowdown that began in China and migrated around the world continues today. It was exacerbated by uncertainties caused by the Trump administration’s tariffs and trade tensions, which have intensified lately. But there are signals that the end of the downturn might be ahead.

“Leading indicators compiled by the Organization of Economic Cooperation and Development (OECD) for China and a group of five other major non-OECD countries have both moved higher for four months. The OECD leading indicator for all member countries is nearly flat and likely to turn up shortly. Broad commodity price indices seem to be nearer consolidation than further collapse. The Baltic Dry Index of shipping costs surged this year. Recent economic data and business surveys were better than expected in Taiwan, as was June industrial production in South Korea. This suggests the end of the Asian downturn is at hand.

Why U.S. business leaders lack confidence

“Some have wondered why U.S. business leaders lack confidence and convey pessimism, why capital spending has been so lifeless recently. Part of it was uncertainty about trade issues, but, the more likely reason became clear with the sizeable revisions to U.S. NIPA data. That big upsurge in worker income noted above came out of U.S. corporate profits, meaning total earnings have been broadly flat since 2016, rather than rising. A surge in interest costs, rising wage pressures, and a failure of revenue to match. It’s no wonder CEOs are so glum: no profits, no spending, no way.

“The bigger picture is that the lack of profit growth suggests the U.S. may be later in its business cycle than some have thought. Flat or contracting profits is one of three typical long-leading signs that a recession, however mild, may be out there somewhere in the future; now, likely still a ways ahead – We don’t think recession is a worry for this year, nor is it likely next, as these harbingers have a long lead time. But they do herald that the end-cycle is coming.”

No long-term trends, no passive index for investors to jump aboard: why a good long-term return may be hard to find

“The risk of a bit more inflation and higher long-term interest rates may create a challenging environment for investors after 2020. Higher interest rates could bring significant distress in the corporate bond market with prospects of rising defaults. The super-low cost of debt over the last decade has likely kept inefficient companies in business by allowing them to roll over their loans. Higher rates will put the hurt on whatever zombie companies are still operating. Higher mortgage rates will dent housing activity around the world.

“If this milieu comes to pass, good financial returns will be very hard to find. Most financial assets, especially safe-haven government bonds, have very high valuations today, and they are unlikely to become much cheaper into mid-2020. Neither stocks nor corporate bonds will like the environment that could coalesce in 2021, if a bit of inflation returns with higher long-term interest rates. If the worst comes to pass in 2021, cash and safe-haven U.S. or Japanese government bonds would be the place to ride out the lurch. Eventually, this could bring a big rotation to value stocks and real assets (i.e., banks, financials, industrials, materials, real estate, commodities, emerging markets).”

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Bob Baur

Interest rates: near a low in long-bond yields 

“The eight-month plunge in 10-year U.S. treasury bond yields is likely over. Yields will slowly work higher into year-end. At some point, rising interest rates will become a problem for stock and credit markets, likely late next year or in 2021. 

“For 35 years, yields on 10-year U.S. treasury bonds kept falling, from 15.8% in 1981 to 1.3% in 2016. After that long drop, plus a decade of deflation dread and near-zero interest rates after the financial crisis, it’s no wonder investors are certain inflation and interest rates will stay lower for longer.  

“However, no trend lasts forever, even one that lasts for 35 years. It just becomes easier to extrapolate. The world growth slump and tepid inflation are what’s keeping safe-haven, government bond yields at mind-bogglingly low levels. Both may be about to change, for a few reasons: 

• First, long-term bond yields will begin to reverse their decline once the expected rebound in world growth becomes evident later this year 
• And second, inflation has been weak the last several months as a lagged effect of the world growth slowdown from mid-2018. The most recent data suggests this year’s down pressure on inflation is fading. Tight labour markets and rising wages have been a consistent theme in developed countries.   

Looking ahead  

“The Fed should still follow through on their implicit pledge to lower the fed funds rate by 0.25% in July and perhaps again in September. That will reverse the yield curve inversion, extend the expansion as Fed Chair Jerome Powell described, and keep the labour market pulling workers off the sidelines.  

“Following these cuts, the Fed will surely have a high bar to raising rates again. The next rate hike may not be until inflation has been at or above the Fed’s target for at least a few months, likely well into 2020.”  

World economic outlook

• The US: “Happy birthday to the expansion that begins its eleventh year this July, making it the longest in U.S. history. Trade uncertainties aren’t impacting small businesses yet, where expansion plans and optimism are near-record.” 

• China: “The restrictions on debt growth that brought the slowdown to China have been removed and funds are flowing. Interest rates and tax rates are lower, required reserves for banks have dropped, and public infrastructure spending has ramped up. Using official data, growth in China will likely hit the government’s 6.0% to 6.5% target range for 2019. Growth may fade in 2020 and beyond as the stimulus wane, the labour force starts to contract, and increasing debt fails to provide much of a further boost to growth.” 

By Bob Baur, Chief Global Economist at Principal Global Investors

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Bob Baur

Principal’s Chief Global Economist, Dr Bob Baur, looks at how global markets fared in March.

World economic outlook: green shoots

“Stock markets plunged in December as evidence began to accumulate that a recession might be around the corner. Growth in China slowed significantly throughout 2018 and the fourth quarter rebounds in Europe and Japan were modest at best. The Fed added to the gloom by raising the fed funds rate and sticking to its prior  hawkishness and sentiment plummeted with stocks.

“Cooler heads prevailed in late December and stock markets rallied as investors anticipated the end of the slowdown. The late March stall may be investors waiting until some actual green shoots to validate the upsurge in stock prices. Those signs are starting to appear. After stabilising in the second quarter, world growth should pick up mildly as 2019 progresses.”

United States: chasing Australia

“Even with a weak 2.2% annualised growth in the fourth quarter, the U.S. economy expanded at a robust 3% pace from the fourth quarter of 2017. However, the government shutdown that lasted into January will keep any rebound modest. That drag, along with seasonal adjustment problems that the Bureau of Economic Research can’t seem to eliminate, may keep U.S. first quarter growth below 2%.

“If this U.S. expansion lasts through July, it will become the longest in U.S. history. While we doubt the next U.S. recession will be 27 years away like Australia’s current record run, whatever downturn comes will likely be mild and several quarters away. Investment growth should be healthy, albeit not as fast as the spectacular 7% pace of 2018, and we expect U.S. gross domestic product (GDP) to grow around 2.5%, driven by sturdy investment and strong consumer spending gains.”

China: a billion here, a billion there …

“Last year’s slowdown in China’s growth was somewhat self-imposed from an official attempt to slow the growth of debt. The idea likely was to prevent excess debt from creating a financial crisis in the future. That drag coincided with another obstacle to growth, reducing the pollution in China’s major cities. Add the trade dispute with the U.S. and the global growth downshift and China’s slump became worrisome. Starting last year, officials began to energise the economy with several rounds of stimulus.

“The improvement in the latest business surveys suggest that growth has stabilised already. Using official figures, growth will likely remain around 6% for 2019, although we would expect any uptick to fade into 2020 as the stimulus wanes.”

Europe: tighter labor markets, rising wages

“Slowing manufacturing activity, softening Chinese import demand, and political tensions have kept a lid on Euro area growth into 2019. Italy fell into a technical recession and China’s slowdown almost pushed Germany into one. The latest business surveys for March are still edging lower. But job growth has been stout, with the jobless rate the lowest in a decade. That puts upward pressure on wage growth, which in turn boosts household consumption.

“The European Central Bank (ECB) responded to the downshift in growth by extending its no-hike guidance through the full year and announcing new liquidity provisions, a strong banking system support. It also appears that fiscal policy will become more expansionary after Euro area elections. We expect growth to be positive but uninspiring in the 1% to 1.5% range this year and into next.”

Emerging markets: a favorable tailwind

“For several quarters, India has been the fastest growing major country in the world. Since taking office, the Modi government enacted several changes that were initially economic drags but with long-term positive effects. Those changes have shown up in India’s recent 7% pace of growth. Business surveys are edging higher and new manufacturing orders are strong. The SENSEX Index is pressing up against new highs and inflation seems under control, at least for the moment. The central bank will likely cut rates another 0.25%. GDP growth could remain in the 6.5% to 7% range.

“A China growth pick-up later this year would help lots of developing countries, especially in Asia. In addition, U.S. interest rates have fallen substantially. The U.S. dollar isn’t making new highs. These events, plus a gradual pickup in world growth, will provide a decent tailwind for emerging markets as 2019 progresses.”

Download: Economic Insights – March 2019

The post US chasing Australia on economic expansion, says Principal appeared first on AdviserVoice.

Bob Baur

Market outlook: Is the monster rally over?

“Last month, I suggested the odds favored another market downdraft, something approaching December’s lows. Didn’t happen; stocks kept roaring higher. The S&P 500 Index soared 6.6% in December, 7.9% in January, and 3.0% in February, for a total 18.4% compound gain since Christmas. That’s an amazing run. Of the 46 world equity indices Principal tracks, none—not even one—had a negative return since Christmas. Well over half had double-digit returns.

“Is this the beginning of another long bull market? Doubtful. Central banks want to unwind the decade of suppressed interest rates and financial repression they oversaw. Stock and bond markets got used to that low-interest subsidy from central banks and the volatility in 2018 was the initial adjustment to that new monetary environment. In addition, world growth slowed in 2018 and the weakness persisted early this year. Markets are likely reflecting too much earnings optimism. Further, it often takes 12 to 18 months for the full impact of central bank tightening to become apparent. So, the 2018 Fed rate hikes and bond sales have not completely worked their way through the financial system – we’d stay cautious a while longer.

“Long-term, we may be close to the start of a radically new investment environment, one where real estate, value stocks, and commodities return to the fore after a decade of underperformance. It depends on wage growth. Notice the similarity of improving labour markets and a pickup in wage growth across major developed economies—U.S., U.K., Eurozone, and Japan. If this trend continues, central bank worries of deflation will evaporate, and inflation edges toward most countries’ targets. Long-term interest rates will reflect a little more inflation premium, which is good for financials. Businesses may find some pricing power, which is good for value stocks. Developed-country stock markets may stay bound within a range for some time as interest rates gradually work their way to more normal levels.”

Economic update

“We think the global slowdown is winding down. Global growth slowed in 2018 and it’s still braking a bit. China decelerated sharply but may pick up by mid-year. Idiosyncratic problems ranging from natural disasters and protests, to changing auto emission standards, dragged down activity in Europe and Japan. The U.S. economy resisted the weaknesses elsewhere, but first quarter growth is hiccupping. If official stimulus in China kicks in, world growth could pick up in the second half.”  

China: a pause in the structural deceleration

“Activity in China may be stabilising. Our proprietary growth indicator, based on a broad range of hard data, improved somewhat. Total social financing accelerated sharply in January, although there may be some noise associated with the Chinese New Year. Exports rose significantly but may be biased by the holiday. Business surveys were mixed; the official manufacturing index fell further while the private Caixin survey rose a bit. Both still show contraction. Surveys of service sector businesses rose handily, suggesting stimulus has started to stabilize growth already. We look for activity to pick up modestly in the second half of 2019.”

Japan: the expansion continues

“Exports plunged and industrial production contracted for a third straight month. Corporate profits declined in the fourth quarter as manufacturing companies feel the Chinese slowdown. Japan is part of the global supply chain that’s being disrupted by the trade dispute between the U.S. and China. U.S. auto tariffs loom for Japan and Europe as well. The labour market remains a bright spot with an incredibly low jobless rate of 2.5%. The ratio of job openings to the number of applicants is 1.63, around the highest since 1974, so there are plenty jobs for workers. However, the growth risk is likely on the downside; retail sales are struggling and a drop in profits may impact capital spending. Still, we look for 1% growth in 2019.”   

India and other emerging markets

“Easier financial conditions, a pickup in Chinese growth, and a weaker U.S. dollar should translate into less risk for emerging markets this year versus 2018. Risks will vary by country. For example, Fitch downgraded Pemex, the state-owned Mexican oil company, at the end of January, and bonds from South Africa may be in peril of a downgrade, too. Growth slowed in India in the fourth quarter to 6.6%. With the manufacturing survey index picking up to a nice 54.3, and the central bank liable to cut rates more, growth should move up above 7% as 2019 progresses.”

Europe: a trough in the slowdown

“European manufacturing activity remains weak but the services side of the Eurozone economy is better. Consumer confidence fell but remains mostly solid, likely because the labour market is holding up well. The jobless rate keeps dropping, now at 7.8%, down 0.8% from early 2018 and the lowest in a decade. This good job news is broad-based throughout the Euro area. That’s why wage gains are picking up and household consumption is driving growth.”

By Dr Bob Baur, Chief Global Economist

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Risk of a Turkish default.

Principal Global Investors’ Chief Global Economist, Bob Baur, takes a look at how Trump’s sanctions and a threat of tariffs on Turkish exports to the US are propelling the downdraft 17 August 2018 Trade, Turkey, Tariffs, Trump and turmoil “The currency had already been weakening this year, along with emerging economies in general, on account of accelerating headwinds.

Those obstacles include a decelerating Chinese economy, broad relative U.S. dollar strength, rising yields on long-term U.S. Treasury bonds, and falling commodity prices. Challenges like these always hit the most vulnerable currencies first, like Argentina, Brazil, Turkey, and Russia.

“Turkey is especially vulnerable with a high level of debt from foreign lenders denominated in U.S. dollars. And, as the lira weakens, loan repayments become increasingly difficult. So, bond prices tumbled, pushing yields on Turkish 10-year bonds over 20%.”

The search for yield brought foreign investors to Turkey in droves…

“Foreign funds flowed into emerging countries fast and furiously in recent years as investors feasted on the higher yields offered on that debt. World growth peaked around the end of last year even as the U.S. economy continued to gain momentum. That brought relative U.S. dollar strength and higher long-yields, while decelerating world growth put the pinch on commodity prices.”

Will President Erdogan instigate controls to stem the currency collapse?

“Turkey faces a myriad of problems: double-digit inflation, an enormous current account deficit, which requires even more foreign capital to finance, slowing growth, low productivity gains, and too much debt. After many years in office, President Erdogan was newly elected again; he sought and was given expanded powers. The fear is that he will institute controls to prevent foreign investors from taking their funds out of Turkey, whether loan payments or investment returns. The President’s hope is that controls would stem the currency’s collapse and lessen the need to raise official interest rates.”

Risk of a negative contagion effect from a Turkish default

“European financial institutions were big lenders to Turkish borrowers and are the most vulnerable to any potential default. Investors also have significant exposure to Turkish defaults through emerging market debt funds. U.S banks have limited exposure to Turkey. The International Monetary Fund would be a likely backstop as has happened in past emerging market crises.” “The biggest concern is the negative contagion that a Turkish default would bring to emerging market debt and stock funds. Investors might not be able to differentiate among countries and the contagion could tar all with a negative brush.”

Tariffs and the impact on US growth momentum

“So far, there is little hard evidence that President Trump’s unorthodox trade negotiations have put a dent in U.S. growth momentum. Stiff tariffs would raise prices and inflation somewhat, at least temporarily, but, job gains and wage growth might be an offset as global companies manufacture more goods in the United States. The impact of rising short- and long-term interest rates, which impact all of the U.S. economy, would seem a bigger problem than tariffs. Offsetting both would be the large reduction in corporate tax rates that helped bring the surge in U.S. growth momentum and confidence.”

Investment implications

“Over the last few months, markets have shrugged off the impact of rising trade tensions even though they fill the headlines. That may not last; the combination of contagion from Turkish debt issues and more tariff threats may bring a downdraft in world stock markets, so near-term caution is warranted. Emerging economy debt and equity markets have underperformed most of this year; that trend will likely continue. The uptick in U.S. inflation will likely keep the Fed on its path of rate hikes. It could easily promote another move higher in yields on long-term U.S. Treasury bonds.”

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