James Bevan: China the big risk to growth in 2015

Whilst global industrial production rebounded from the weakness seen in the middle of last year, markets have been unimpressed and risk appetite looks significantly depressed. This is important because either markets have traded to levels that are too cheap or they are signaling downside risks to the outlook for growth. As to what the risks might be, the key challenges to global growth look to be from China, Germany, and the US energy sector.

With China, underlying growth trends are slowly converging toward lower rates and policymakers are pursuing reforms to facilitate a smooth transition. China now accounts for a quarter of global manufacturing and a fifth of global goods demand, and its share of global goods sector activity continues to grow apace, even as its growth rate slows. The size of the economy is such that its potential problems scare global investors as well as China’s own policymakers. Excessive growth could lead (or has led) to severe problems with resource misallocation, credit growth, and pollution – but the fast growth seen before 2008 seems to have passed and the risk now is that growth slows too fast with the sharp fall in the prices of commodities sensitive to China’s growth contrasting with the shift up in domestic equity prices. China’s trends of declining investment, commodity imports and manufacturing capacity growth are all consistent with moderation of underlying growth, which looks likely to be seen in the months ahead, even if growth in the rest of the world accelerates. But global trade volumes have picked up, and lower oil prices should support goods demand in leading economies, which in turn should support growth in China and elsewhere. Meanwhile, stable growth in China’s services sector may be cushioning the labor market from the impact of slowing growth in manufacturing.

Germany’s economy has been the key swing factor in overall Euroland growth and despite the data showing decent German export growth over 2014 as a whole, it is exposed to both the slowdown in China and the sharp decline in Russia and other emerging markets. First order hits have been compounded by slowing domestic investment, but there are signs of a rebound. Thus after six straight declines, Ifo expectations have risen and PMIs are generally expected to follow higher. This stabilization in corporate sentiment suggests further downside in investment should be limited and Germany is well placed to benefit from even a modest pick-up in global growth, but it also remains vulnerable to any downturn in global economic conditions and sentiment.

With regard to energy pricing, weakness in Europe and Asia may have driven the large recent decline in oil prices and US industrial production should be negatively affected by declines in energy production, even if overall US manufacturing activity remains strong, with US shale the most likely candidate to balance overall supply. US supply may not contract outright but growth should slow considerably since the trough in US industrial production in June 2009, oil and gas mining has added 50bps to trend growth and more than doubled its index weight from 6.2% to 13.5% of total industrial production. Against this backcloth, whilst the net effect of lower oil prices is very likely positive for the US economy as a whole, it’ll likely be some time before steadier manufacturing can make up for the declines in energy.

Our net conclusion is that there are good grounds for optimism in 2015, although there may be a modest decline in momentum of global industrial production in the first quarter. China remains the biggest risk – but if steady albeit slower growth is confirmed, equities should enjoy a significant rally.

Photo (cropped) by Jonathan Kos-Read