Investment Outlook for September 2019
In spite of widespread publicity surrounding the probability of a global recession (often accompanied with downgrades of growth projections), and increased uncertainties surrounding international trade and the robustness of growth trends, underlying structural trends continue to point towards a continuation of global economic growth this year and next, although incoming statistics will likely exhibit more volatility than a simple straight extrapolation of data points would suggest.
Over the last few months the incoming economic evidence has not offered compelling reasons to deviate from our view that economic policies, although igniting volatility at times, are unlikely to disrupt the longer-term favourable growth outlook for the world economy. Our confidence regarding the growth outlook is, to a significant degree, based on the downward pressure on interest rates in western democracies where central banks continue to pursue accommodative policies that go a long way in compensating for any weakness caused by the trade war.
Relatively low fixed income yields can be expected to continue to offer a favourable tailwind to interest rate sensitive parts of the economy and the valuation of risk assets. Global equities continue to offer superior investment opportunities to most other asset classes and remain “the only game in town”.
FED policy: Insuring against the trade war?
Against a background of increased investors’ question marks regarding the sustainability of positive market trends, the Fed’s recent rate cut, and the prospect of further rate cuts in coming months, offers a supportive backdrop for the world economy. In this regard it is worthwhile to recall the Fed’s comment accompanying the latest policy measures:
“..the Committee decided to lower the target range for the federal funds rate to 2 to 2-1/4 percent. This action supports the Committee's view that sustained expansion of economic activity, strong labor market conditions, and inflation near the Committee's symmetric 2 percent objective are the most likely outcomes, but uncertainties about this outlook remain. As the Committee contemplates the future path of the target range for the federal funds rate, it will continue to monitor the implications of incoming information for the economic outlook and will act as appropriate to sustain the expansion, with a strong labor market and inflation near its symmetric 2 percent objective.”
The Fed’s monetary action has been interpreted as a disappointment by those investors who had been positioning their investment portfolios for more drastic monetary easing in light of the increased trade issues. Federal Reserve chairman Jerome Powell acknowledged that the economy has grown more turbulent since the Fed cut rates, but stopped short of giving any indication about what might be decided at the rate-setting meeting in September during his address at the annual economic symposium in Jackson Hole in Wyoming. Powell stated that there are “…no recent precedents to guide any policy response to the current situation. Moreover, while monetary policy is a powerful tool that works to support consumer spending, business investment, and public confidence, it cannot provide a settled rulebook for international trade. We can, however, try to look through what may be passing events, focus on how trade developments are affecting the outlook, and adjust policy to promote our objectives.”
The recent rate cuts by the Fed have been labelled as “insurance cuts” to avoid a serious economic fall-out from the on-going trade war between China and the US.
Similar insurance cuts were used in 1995 and 1998 by Alan Greenspan Fed to combat an economic slowdown and successfully prolong the expansion, which at the time became the second longest in U.S. history. During that period the Fed reduced interest rates three times, for a total of 75 basis points, against risks associated with the Mexican and Russian defaults and the collapse of Long-Term Capital Management.
The trade war: economic effects are becoming noticeable
The latest developments in the trade war can be summarized as follows:
* The United States will raise its existing tariffs on $250 billion worth of Chinese imports to 30% from the current 25% in October;
* Tariffs on the remaining $300 billion worth of Chinese increase to 15% from 10% in September 1 but tariffs on about half of those goods have been delayed until December 15.
* China announced tariffs on $75 billion worth of U.S. imports ranging from soybean to ethanol.
* China will resume tariffs of 25% on cars and 5% on auto parts and will increase tariffs to 10% on some other 5,000 U.S. products. A 25% tariff on American-made cars would be reinstated.
* The effects of the trade war are becoming more noticeable in the wider US and Chinese economies. U.S. soybean exports to China were at their lowest level since 2002 in the January-June period. Pork exports are at a nine-year low, and shipments of U.S. sorghum are down 96% from a 2015 peak.
* Tariffs are costing the U.S. tech sector $1.3 billion a month, the Consumer Technology Association stated. The U.S. plan for more tariffs would raise the retail price of cell phones by an average of $70, laptop computers by $120 and video game consoles by $56, the association has said.
* On September 1 the Trump administration has additionally introduced a 15 % tariff on $112 billion worth of Chinese goods ranging from milk to technology products. For its part, China will introduce tariffs on some USD75bn of US imports.
The effects of the trade war can be expected to increasingly affect corporate results starting this year and becoming more pronounced in 2020 as companies increasingly deplete product stock. For example, many best-selling Apple products already face 15% levies as of September 1. The American Apparel & Footwear Association estimates that some 77% of U.S. imports of apparel and other textile products (some $39 billion) have been affected by 15% tariffs on September 1.
Estimates for the economic cost related to the trade war vary widely but increasingly point towards a noticeable dent in the global economy. Estimates of the cost of tariffs to the American consumer varied between $600 to $1000 a year before the latest escalation of trade measures announced at the start of September.
So, what is the best estimate for global GDP growth now and, importantly, has a global recession in 2020 become more likely? Assuming full implementation of trade measures by the US the best guess for prospective global GDP growth now would remain at slightly above 3% compared to an old estimate of 3.2% for this year and about the same for 2020 (vs. the old estimate of 3.5%) applying the existing IMF projections and incorporate recent estimates of the trade war effects. These estimates have a higher than normal level of uncertainty (in reality it is almost impossible to calculate the net economic effect of the trade war) but, as time passes and trade measures accumulate it seems safe to assume that there will be a noticeable effect on the world economy although a global recession still looks unlikely.
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The views expressed in this article are those of the author at the date of publication and not necessarily those of Dominion Fund Management Limited. The content of this article is not intended as investment advice and will not be updated after publication. Images, video, quotations from literature and any such material which may be subject to copyright is reproduced in whole or in part in this article on the basis of Fair use as applied to news reporting and journalistic comment on events.