October 2019 Economic Update “Syncing Downwards”

In our increasingly interconnected and globalised world no country is immune from a trade and currency war between the world’s two largest economies. This month we find ourselves in a global synchronised downturn. Tensions in several the world’s hot spots eased this month but the economic and political tensions across the US and China trade war and Brexit did not. Consensus forecasts amongst economists is for global growth to continue its downward trend in the December quarter before bottoming sometime in the first half of 2020 at an annualised rate of around 2-2.2%.  This assumes a reasonable and orderly resolution to both Brexit and the trade war.

Macro-economic concerns increased this month as data point after data point confirmed the ongoing deterioration in global economic activity and confidence.  Escalating trade tensions saw the World Trade Organization (WTO) revise global trade forecasts to 1.2% for 2019 (down from 2.6%) this month, well below calendar global GDP forecasts of 2.3%.  Global trade growth is a key indicator for global economic and geopolitical health and stability. The deteriorating trade outlook in our view poses the biggest potential trigger for a steeper downturn.  

One of the most closely followed economic indicators is the Purchasing Managers Index or PMI. This index, covering major economies and sectors, surveys the forward order books and buying intentions of managers. A reading above 50 signifies expansion and below 50 contraction. The chart shows the PMI index for global export orders since the start of 2010. The index fell below 50 in August 2018 and continues to trend downwards. The downward trend accelerated last month with the index falling to 47.5 its lowest reading since October 2012.

In the USA annualised growth was 2% for the June quarter down from 3.1% in the March quarter. Forward indicators particularly in those sectors exposed to international trade and international investment suggest growth is trending lower. That said, the US economy in relative terms remains in good shape supported by continued strong consumer spending, rising wages and record low unemployment. This is not the case in Europe where annualised growth is now running at less than 1%. Europe remains the most vulnerable to a technical recession in the short to medium term (defined as two quarters of negative economic growth). Again, it is the trade exposed industrial sectors in Europe’s industrial powerhouse Germany where forward indicators across sectors such as industrial equipment and autos are looking particularly weak.  In China GDP growth slowed to an annualised rate of 6.2% in the June quarter down from 6.4% in the March quarter.  Market consensus is for GDP growth to come in at about 6% for the September quarter (due mid this month). With economic indicators trending lower it will be interesting to see if China lets growth fall below their stated target of 6%.  

Monetary policy remains the weapon of choice across the globe to counter slowing economic growth and trade and maintain competitive exchange rates. The race to the bottom on interest rates continued this month and is as much about currency versus the stated narrative of supporting economic growth, employment and inflation targets. On September 18^th the US Federal Reserve cut rates by another 0.25% to 1.75 to 2.0% stating the US economy remains strong with low unemployment but risks are increasing and if the economy weakens, further rate cuts may be required to sustain continued expansion.  On September 12^th the European Central Bank cut interest rates again on deposits to negative 0.5% and relaunched its bond buying program to further stimulate the economy and ward off recession.  In China The Peoples’ Bank of China (PBOC) lowered the bank reserve ratio (the amount of reserves banks are required to hold) by 0.5% for the seventh time since early 2018 to encourage bank lending and stimulate the economy.  Interest rates for their prime one-year loan rate were reduced albeit only by 0.05%. 

Australia followed suit with the Reserve Bank lowering rates by 25 basis points to a record low of 0.75% on October 1. In his commentary RBA Governor Philip Lowe stated for the first time that “the board also took account the forces leading to the trend to lower interest rates globally and the effects this trend is having on the Australian economy and inflation outcomes.” In other words, Australia has little choice but to participate in the race to the bottom on interest rates if it wants to maintain a globally competitive exchange rate.

As noted last month Australia recorded its lowest rate of economic growth since the GFC in the June quarter at 0.5%. Slower growth saw the unemployment rate increase in the latest August survey from 5.2% to 5.3% while the monthly underemployment rate remained steady at 8.5%. Employment trends nevertheless remain the main positive indicator both here and abroad. The US jobs report released on October 5^th showed unemployment fell from an already record low of 3.7% to 3.5%.  In Australia the workforce participation rate continued its steady upward trend. Jobs growth in the latest survey was not enough to stop the unemployment rate rising slightly but the proportion of the population aged 15 years and over in the workforce continues to rise.

In sharp contrast to the rest of the world one of the main positives for our economy is the trade sector. Our monthly trade surplus fell in August from recent record highs reflecting lower iron ore and coal prices but the positive momentum in both the volume and value of our commodities continues.  Demand for commodities might be slowing but remains healthy.  Importantly, Australia is wining market share of global trade due to a combination of luck (e.g. supply issues in iron ore out of Brazil), our competitive positioning as a low cost and reliable supplier and our geographic position close to the main growth markets in Asia. Strong demand combined with the balance sheet strength of our miners now flush with cash is also expected to see growth in mining exploration and capital expenditure increase from here.  This combined with increased infrastructure spending should lift overall investment and more than offset the decline in housing.

As to the equity markets it would appear complacency has shifted to concern this month as the macro global backdrop continues to deteriorate and flows through to company earnings. Volatility is increasing. Two conflicting forces are at play.  On the one hand further falls in interest rates make equities look reasonable value in relative if not in absolute terms.  On the other hand, earnings growth is now slowing. Share price growth is now trending above earnings growth at a time when markets are already fully priced and overvalued relative to history.  Unsurprising given this backdrop it appears probable October will live up to its reputation of being the most volatile month for markets.  Should this occur we remain well positioned to capitalise on opportunities as they present themselves.

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Sources:  Commbank Global Markets Research, RBA, Morningstar.