It’s hard to tell where economic fundamentals end and fear begins right now. Last week US bond yields ticked up briefly when President Donald Trump waylaid Chinese tariff increases until later this year. But then fears of global recession sent yields racing back to historic lows as investors piled back into US government bonds.
The data point that triggered the panic was the German second-quarter growth number. Investors interpreted the 0.1% contraction in German GDP during the second quarter as indicative of evidence that a broader global recession was coming. The dramatic turnaround in sentiment saw US long bonds fall below 2% for the first time and the two to 10-year bond yield invert for the first time since 2007. Around the world, the amount of negative-yielding debt increased by $2-trillion to $17-trillion in a week.
This week, however, relative calm returned and with it much debate about the likelihood of a global recession. Discussions centred on whether fears of a global recession could become a self-fulfilling prophecy. Reflexivity, a term used by George Soros, was also considered. Reflexivity is a feed-back loop between investors and the financial markets. It is believed to occur when things investors expect to happen, happen because of how they act.
If this is the case, then what we saw last week is the beginning of a destructive spiral that could end in a global recession. But is this the case? Are economic conditions as dire as recent investor actions suggest?
Time and again, the economic statistics confirm that the world has a problem in the manufacturing sector. But consumers are still holding up their end of the deal, with retail sales showing respectable increases. That’s why Trump was loath to activate the most recent round of consumer goods-centred tariffs before the Christmas shopping spree in the US ends in December.
The IHS Markit July Manufacturing Purchasing Manager’s Index’s across the leading economies have shown that only the US is above the 50 level. A reading above 50 signals an economy is expanding, not contracting. In most instances, there has been a three-month consecutive decline in the index level, with the Eurozone now at 46.4, UK at 48, China at 49.7 and South Africa at 48.4. In the Eurozone, Germany’s PMI hit a seven-year low of 43.1, while France’s is on the cusp, at 50, stalling after a strong June reading. The US’s PMI edged down to 50.4 from 50.6 in June.
The US economy is still looking relatively healthy, with most economic statistics confirming that it is on track to be the fastest-growing G7 country this year. Old Mutual Multi Managers investment strategist, Izak Odendaal, points out that all the latest reports on the US economy show healthy levels of consumer spending, supported by a strong job market, low inflation and low-interest rates.
On the outlook for the US, JP Morgan Chief Global Strategist David Kelly says:
“In the middle run, that is, over the next few years, the U.S. economy may grow slowly but could well avoid recession.”
He believes the real economy has become more stable over time and that the banking system is “far better capitalised” than a few years ago. Kelly expects this to limit the risk of a 2008 crisis happening again. His take:
“There are few signs of an economic boom anywhere that could turn into an economic bust.”
In Germany, Odendaal says the contraction in the second quarter is no surprise because the economy is heavily dependent on exports, particularly in the struggling automotive industry.
“It is also exposed to China, where July data showed the economy slowing more than expected, and to the UK, plagued with Brexit uncertainty.” However, Germany is one of the few countries that has fiscal firepower to reignite economic activity. Whether it will or not is up for debate though.
Odendaal says, “The entire German yield curve is now submerged below zero, screaming for the tight-fisted German government to borrow more and spend more. But the country’s leaders remain committed to the schwarze Null (black zero) of a balanced budget. In ordinary times, that might be commendable, but these are clearly not such times.” What does matter is that the fiscal capacity does exist should economic conditions in Germany deteriorate so much the government has little choice but to use it.
So it’s clear that the global economy is not yet on the brink of recession and the fears that took hold last week may well be overblown. At times like these, it’s always worth stepping back to consider the overarching macroeconomic landscape. It’s worth distinguishing between fears that may never materialise and the deep underlying economic fundamental shifts that are underway and deserving of our attention.
Ruchir Sharma, author of The Rise and Fall of Nations: Forces of Change in the Post-Crisis World and the chief global strategist at Morgan Stanley Investment Management, did just that in his New York Times opinion piece last week. It was a breath of fresh air that brought to the surface some of the important world economic issues.
He points out that the post-war growth miracle is over and “no major economy is growing as fast as it was before 2008”. He attributes this to the four deeply structural challenges the world economy is grappling with: “Deglobalization of trade, depopulation as labour forces shrink, declining productivity and a debt burden as high now as it was right before the crisis.”
Sharma proposes that instead of trying to “help cure many countries of irrational anxieties about ‘slow’ growth,” we should understand that economies will slow – and even contract – given these systemic realities. He considers it a more worthwhile exercise to redefine the standards against which we define economic success.
“To keep calling two negative quarters in a row a ‘recession’ implies that this outcome is somehow abnormal or unhealthy. That will no longer be the case,” Sharma says. “To avoid overreacting, the discussion about economic health needs to shift to measures that better capture satisfaction and contentment, like per capita income growth.” He makes an important point: it is not a problem if growth is slowing at a rate that is still faster than the population growth. In this event, per capita growth will continue to rise.
It is these factors that all economic and financial market role players should be coming to grips with. They highlight how materially the underlying global economic dynamics have shifted and what we can realistically expect from the world economy going forward. Then our actions could come from a place of grounded wisdom rather than fear. DM