Economic Outlook for November 2017
A Goldilocks economy is generally thought to be characterized by moderate growth (close to a long term trends), subdued inflation, low unemployment, low interest rates and rising asset prices. Based on recent economic evidence and, judging by lead indicators and forecasts, one can conclude that the world is indeed in Goldilocks territory. This backdrop has gradually become more pronounced in the course of the year but increasingly raises the question regarding its robustness and duration. Prudent investors can be forgiven for thinking that a pullback in equities cannot be ruled out after a strong performance so far this year.
Obviously equity indices do not rise in a “straight line” but fortunately, fundamental economic trends are also showing some acceleration and corporate results continue to offer positive surprises. In this scenario global equities’ valuations continue to hover within historic ranges (with a possible exception of the US market where a potential tax windfall is being partially being discounted) and have avoided moving into over-bought territory. Improving clarity of monetary policies also support investors’ outlook. With a well understood, and generally accepted, normalization process of interest rates in the USA and Europe underway, the backdrop remains conducive for investment holdings over longer periods which underpins the valuation of growth stocks in particular.
An entrenched leader in China
The main geo-political event during October was probably China’s 19th Party Congress. Commentators notice that, due to the lack of an obvious successor, president Xi has reinforced his position to such an extent that comparisons are even being made with Mao. This has led to speculation that a powerful Xi might surprise with new policies, just as he did with the anti-corruption drive over the last five years. It is expected that policy initiatives regarding issues like the environment, restructuring of state-owned companies, lending growth and boosting consumption will become clearer over the next few months.
In the meantime the Chinese economy continues to be one of the main drivers of the global economy. Analysts no longer foresee a reduction in the Chinese growth rate this year and have moved the “slow-down scenario” one year forward to 2018. Much will depend of course on how the Chinese policymakers’ efforts to boost consumption growth at the expense of investments will affect the pace of expansion at a macro level in the short term.
Important growth upgrades
The IMF published its October World Economic Outlook which included an upgrade of the global growth rate from 3.5% to 3.6% (the 2018 forecast was also increased by 10bp). More importantly, the IMF changed its “tune” to a more positive assessment of the world economy as can be read in its introduction to the projections:
“The global cyclical upswing that began midway through 2016 continues to gather strength. Only a year and a half ago, the world economy faced stalling growth and financial market turbulence. The picture now is very different, with accelerating growth in Europe, Japan, China, and the United States. Financial conditions remain buoyant across the world, and financial markets seem to be expecting little turbulence going forward, even as the Federal Reserve continues its monetary normalization process and the European Central Bank inches up to its own.”
Global GDP Growth
SOURCE: IMF World Economic Outlook, October 2017
The bright IMF forecasts might still be too conservative based on recent evidence in the USA and Eurozone. The U.S. economy unexpectedly reached a 3% GDP growth rate in the third quarter (after 3.1% in the second quarter) driven by inventory investments and a reduced trade deficit which more than compensated for the effects of the hurricanes (temporarily leading to slower consumer spending and construction activity). The Eurozone also reported GDP growth ahead of consensus with a 2.5% year-on-year increase compared to 2.3% during the second quarter.
Strong economy justifies monetary tightening
On October 11 the FED published the minutes of its September meeting. These minutes often offer additional background providing a guide with respect to future policy decisions. In light of the favourable, and improving, economic outlook it is therefore of interest to see how that could influence the pace of normalization that the FED has been embarking on. A key section of the minutes suggest that the FED is now less concerned about the reaction in financial markets to further monetary tightening when it states that “Several members observed that, in part because financial market participants appeared to have a clear understanding of the Committee’s plan for gradually reducing the Federal Reserve’s securities holdings, any reaction in financial markets to the announcement and implementation of the program would likely be limited.”
Although the future path of monetary policy by the ECB is less clear than the FED’s, there is no doubt that further strengthening of the European economy will ultimately lead to a similar scenario of normalization. The issue for the ECB board is similar to the FED’s conundrum: According to a number of ECB board members major stimulus is still needed to reach the 2% inflation target. The majority of the board argues, however, that exceptional monetary measures can no longer be justified in a strengthening Eurozone economy.
The ECB has not changed its highly accommodative stance since the global financial crisis and the Eurozone sovereign debt crisis (total ECB assets accumulated through market purchases amounts to more than Euro 4.2 trn). The ECB had already clearly indicated that tapering of QE would have to commence soon. Logically, at its October meeting the ECB decided to cut the Euro 60bn monthly asset purchase programme to Euro 30bn over a nine month period (but it also stated that quantitative easing could be extended again if required).
The reaction of equity markets to the normalization process, implemented in a somewhat more assertive manner by central banks, has been muted: this suggest that equity investors accept and understand the rationale for a return to a more neutral stance. One could go a step further and argue that normal monetary conditions, combined with favourable growth conditions, could further underpin investors’ confidence.
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