While the long post-global financial crisis global expansion is still intact and is providing fundamental economic support for risk assets, it is increasingly being challenged by downside risks, with trade wars and emerging-markets economies the latest worries.
Risk asset classes have also become overdependent on the U.S. economy. All going well, the global and U.S. economies will continue growing through 2019, but the recent pattern of volatility looks set to become an established feature of what are now “late in the cycle” markets.
Global Equities Outlook
Recent geopolitical tensions have taken some toll on world economic activity, though the likelihood is that the post-global financial crisis expansion is still intact and will continue into 2019. The latest global J.P. Morgan composite index of world manufacturing and services activity, built up from the individual IHS Markit country surveys, found that “the rate of global economic expansion slowed to a four-month low, with rates of increase losing traction in both the manufacturing and service sectors.”
There was an especially sharp drop in new orders in the metals and mining sector, which is particularly sensitive to potential setbacks to world trade. But J.P. Morgan also felt that better economic conditions ahead “should hopefully provide a platform for global GDP growth to revive later in the year,” and forecasters generally continue to expect ongoing global economic growth this year and next.
The Economist’s August poll of international forecasters found that they expect all 25 countries surveyed to continue growing in 2018 and 2019, with growth next year anchored by strong growth in India and, despite the trade issues, in China. The latest BAML survey of major fund managers found that they had become slightly more optimistic about global profits.
Overall, the global economic outlook looks reasonably supportive for equities, though, at this late stage in the long post-global financial crisis recovery, the best period may be behind us. BAML’s chief investment strategist, commenting on the latest survey results, said that “With investors telling us they are long the U.S., the Fed and cash, our view remains: peak profits, policy and returns.”
Investors must also hope that the U.S. economy and share market continue to deliver, given that for the year to date they have effectively carried the overall international equity class on their shoulders. On the economic front, the American data continue to be good.
The latest employment data, for example, showed that the unemployment rate dropped even further in July, to 3.9%, and business and consumer surveys are strong.
The latest University of Michigan consumer sentiment survey was also upbeat: “Despite the expectation of higher inflation and higher interest rates during the year ahead, consumers have kept their confidence at high levels due to favourable job and income prospects.” On the share market front, barring some high-profile tech companies that missed ambitious profit expectations, corporate profits have been robust.
Although not all June quarter results are in yet, results to hand show that profits for the S&P 500 companies were up 24.6% on a year earlier. Analysts also have upbeat expectations for the full year they are picking that a profit gain of 20.5% is on the cards for 2018 as a whole – and for a further 10.3% profit rise in 2019.
They currently predict that the S&P 500 will be at 3,148 in a year’s time, which would be an 11.7% increase from its latest close. A generally positive economic outlook may not be enough, however, to turn around the recent lacklustre performance of global equities.
Among the main challenges the asset class faces are the overdependence on the American economy and, within that dependence, the further overreliance on the IT sector.
There are also geopolitical risks and the potential for emerging markets to spring some kind of financials sector shock. There appears to be no sign of any settlement or compromise between the U.S. and China or between the U.S. and other countries and regions it has been targeting with trade impediments.
As the Michigan consumer survey said, “Resolution is critical to forestall decreases in consumer discretionary spending as a precaution against a worsening economy.” Trade war impacts remain the key risk for the fund managers in the BAML survey. And while Turkey is not in itself a huge player in the world economy, its issues could lead to a reduction in investors’ willingness to finance emerging markets in general. In sum, more volatility looks the likeliest outcome.
Investors will be navigating between still supportive global macroeconomics and a variety of challenges, led by protectionism, that might finally derail the global business cycle. A happy–if at this point unlikely – resolution of trade issues might see global growth underpin stronger equity performance, but the more likely outcome looks like further lacklustre gains against a background of rising risk.
