James Bevan: Global growth in focus
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Recent data suggest that the global economy is neither booming nor busting, though many wonder there’s been no boom given the ultra-easy monetary policies provided by all the major central banks of the world for the past few years.
As we know the problem is that growth leading up to the global financial crisis was debt-financed, involving both global consumption and investment. Borrowing by consumers allowed them to spend forward, leaving them with lots of debt and less inclination to borrow to buy today what they can buy tomorrow.
Exacerbating the slowdown in the growth rates of consumer spending around the world are rapidly aging demographic trends as people live longer, while fertility rates have dropped below population replacement rates.
On the investment side, too many companies borrowed too much money to build too much excess capacity. They were extrapolating that consumers’ debt-financed spending binges would continue for decades, led by China.
That certainly explains why the commodity super-cycle wasn’t so super: the commodity boom lasted about a decade from 2001-2011, and has subsequently turned into a bust, particularly this year.
Boom or bust?
But a climate of secular stagnation is actually a bullish scenario for both stocks and bonds. Neither a boom, nor a bust, suggests that inflation should remain subdued while deflationary pressures remain contained.
In such a scenario, central banks continue to provide plenty of easy money, keeping bond yields low. Stock prices should follow the path of earnings, which continue to grow, albeit at a slower pace than in the past when inflation and growth rates were higher.
The climate of low inflation and low interest rates means that valuation multiples could stay relatively high – and that’s the way it’s been during most of the current bull market in stocks.
However looking ahead, the risk from here looks to be more on the side of a bust than a boom as evidenced by the latest GDP data from a number of major economies around the world.
Thus Japan’s real GDP contracted 1.6% (saar) in Q2, following an upwardly revised expansion of 4.5% (saar) in Q1.
Primary areas of weakness contributing to Q2’s decline included private consumption and exports – both were supposed to benefit from Abenomics, but private consumption, which accounts for about 60% of Japan’s GDP, reversed a two-quarter uptrend, falling 3.0% (saar) during Q2.
What was expected was that household spending would be boosted by an increase in real wages. What we ended up with were price increases mostly outpacing wage gains, depressing real incomes and spending.
Meanwhile exports fell 16.5% (saar). This is a big shift as the first decrease in six quarters and was particularly disappointing to commentators because of the significant depreciation of the yen that started when Abenomics was first introduced at the end of 2012. As part of the patch work of inter-connections, demand for Japan’s exports was particularly soft in China.
Euroland did report positive real GDP growth but only just with the flash Q2 estimate at 1.2% (saar). The very easy monetary policy has helped, but bank lending to households and non-financial corporations remains extremely weak. The ECB’s Benoît Cœuré has said that the economic recovery in the Eurozone is “still weak” and “only gradually strengthening”, noting that “the process of getting Greece back on its feet will be long and hard.”
China ruffles
As for China, the briefing that accompanied the Q2 GDP data from the National Bureau of Statistics said the country’s economy is “moving forward while maintaining stability” and Chinese officials “unswervingly pushed forward the system reform and institutional innovation.”
Well quite. As the Economist wrote on 15th July: “China has a history of ironing out the ruffles in its growth figures… No less an authority than Li Keqiang, now the premier, once said that local GDP data were ‘man-made and therefore unreliable’.”
As for hard data, rail freight volumes were down 11.7% year on year (yoy) through June and electricity production was up just 2.8% yoy during July (using the 12-month average). That’s the slowest since October 2009. Using similar measures, Fathom reckon that China is really growing at 3.1% a year, and not the official 7.0%.
Broader problems in Emerging Markets are illustrated by Brazil, where Q1 GDP fell 1.6%yoy. Q1 was the fourth down quarter in a row.
Eyes on the USA
So all eyes on the US – and the good news for those worried about the overall lack of growth is that last week’s July retail sales report showed upward revisions for May and June, suggesting that real GDP growth estimate will be revised higher.
But the Manufacturing lead indicators (M-PMI) are worrying. The New York Fed district is the first to report manufacturing for August, and its composite index fell 18.8 points to -14.9, the lowest level since April 2009. There were also big falls for New Orders (from -3.5 to -15.7) and Shipments (7.9 to -13.8), although inventories also fell – to a 20-month low of -17.3.
As for what’s expected for US equities, consensus expectations for earnings growth for 2015 and 2016 are Large Cap 0.1% and 11.3%; Mid Cap 0.5% and 12.9%; Small Cap 3.3% and 19.0%. Large Cap’s P/E rose to 16.4 from 16.3, but is down from its 11-year high of 17.2 (February); Mid Cap’s edged up to 17.7 from 17.6, down from its 18.6 13-year high (May); and Small Cap’s was up to 18.1 from 18.0, below its 19.6 13-year high (March).
As for momentum, earnings revisions activity for Q3 was mostly negative last week as seven of the 10 sectors of the S&P500 registered a decrease in their earnings forecast and one rose – Energy +0.2% week on week, but this should reverse with falling oil prices.
The biggest decliners were Telecoms (-1.9%), Financials (-0.9%), and Materials (-0.8%). The S&P 500’s Q3 forecast fell 10 cents week on week to $29.31, now off 2.6% since end June and off 9.2% since the beginning of the year. Analysts now expect S&P500 earnings to fall 3.0% year on year in Q3 2015 (pro forma) with the Q3yoy growth forecast down from -2.7% a week earlier, from -0.4% at end June, and from +7.4% at end 2014.
Q2 looks to have come in at c+1.2% with over 92% of S&P500 companies having reported Q2 results. For the record, of the 461 companies in the S&P 500 that have reported, 70% exceeded industry analysts’ earnings estimates by an average of 5.4%, averaging yoy earnings growth of 1.6%. On the revenue side, 48% beat Q2 sales estimates so far, coming in 0.6% above forecast and 4.0% lower than a year earlier.
Trying not to overpay
So we have a delicate and fragile balancing act of optically rich valuations supported by low money rates, depressed bond yields and low inflation, but growth not as strong as hoped. A positive development would involve confirmation of low inflation remaining in place but companies able to deliver decent if not exceptional growth. A less benign development would be bad news on global growth, with companies that disappoint then subject to both pull back of estimates and de-rating. Given this risk, it’s smart to stick with quality and reliability, trying not to overpay. Who ever said that life was boring?
James Bevan is chief investment officer of CCLA, specialist fund manager for charities and the public sector. CCLA launched The Public Sector Deposit Fund in 2011 to meet the needs of local authorities and other public sector organisations. You can follow James on twitter @jamesbevan_ccla
* CCLA is a supporter of Room151
