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Monthly Perspective | July 2019

Markets have rallied following the G20 meeting where Trump and Xi agreed to restart negotiations and place additional tariffs on hold, whilst global central banks have added fuel to the fire by promising easing measures in the months to come.

The S&P/ASX 200 was up over 1.5%, lagging the U.S. S&P 500’s 4.39% return. The S&P 500 breached the 3,000 point mark as it continues to hit new highs. The Euro Stoxx 50 also gained 3.5% and China’s CSI 300 index was up 4.44%. Commodities joined in the rally despite weak global economic growth data, driven by a rally in precious metals such as gold.

Given dovish comments from central banks, bond markets are pricing in a definite U.S. rate cut at the end of July, followed by potentially three more cuts by the end of 2020. This has resulted in a steepening of the yield curve as shorter dated yields fall whilst longer dated yields rise. Despite the steepening, the yield curve remains inverted.

The Australian Dollar continues to hover around 70 U.S. cents, supported by some weakness in the U.S. Dollar driven by the U.S. rate cut outlook.

Economic overview

Locally, the Reserve Bank of Australia followed up with another rate cut to 1% as expected, following a fall in the manufacturing index to below 50 (indicating a contraction) while retail sales and business confidence did not manage to hold up the post-election bump. On a positive note, housing and construction data continue to show signs of stabilisation. The government also passed a tax cut package which should benefit millions of workers in additional refunds for the financial year just passed, with plans for further cuts in the coming years.

Globally, all eyes were on the meeting between Trump and Xi at the G20 summit at the end of June. The outcome was largely in-line with expectations as additional tariffs plans were placed on hold, while the two largest economies agreed to restart negotiations. An unexpected positive was Trump’s decision to partially reverse the sanctions on Huawei, allowing U.S. companies to supply some components.

High level U.S. economic data was encouraging, rebounding from a disappointing set of figures in the previous month. Manufacturing and services indicators came in above expectations, whilst the jobs report was stronger than expected though wage growth remains muted. Inflation figures also came in above expectations but the U.S. Federal Reserve is expected to execute an ‘insurance cut’ in the July meeting despite inflation and employment meeting their objectives. The issue here has been the slowing global economy and the underlying indicators such as transports.

In other major economies, data was mixed, though a rebound in industrial production figures was encouraging.

Markets now have a few major drivers to juggle as underlying economic indicators deteriorate and central banks step back into the spotlight by promising easing measures. Earnings season has also just started, adding to the list of potential catalysts for markets over the next month.

Global slowdown…

Since 2018, global growth has been slowing. Following a period of above-trend, synchronised global growth, we are now in a period where most countries have seen slowing growth and many are currently, or on the verge of a contraction. This slowdown has been led by manufacturing as shown in the chart below.

Source: J.P. Morgan Asset Management, IHS Markit

The chart is colour coded, green represents readings above 50 (indicating growth), yellow represents readings around 50 (neutral) and red represents readings below 50 (contraction). For most of 2017 and early 2018, global manufacturing activity was growing across the board, with developed markets particularly strong. Fast forward to June 2019, we can see that this growth momentum peaked in the first half of 2018 and has slowed materially. Part of the blame goes to the trade uncertainties, not just between the U.S. and China, but also the U.S. and various other parts of the world as the hardest hit economies have been export oriented countries such as Germany, Taiwan and South Korea. The threat of tariffs on autos, Europe, Mexico and Canada have caused uncertainty for global businesses which have held back investment and expansion plans.

But is a recession imminent?

The good news is that the global non-manufacturing Purchasing Managers’ Index (PMI) is still firmly in positive territory, though it has fallen recently as the chart below shows.

Source: J.P. Morgan Asset Management

The non-manufacturing sector is much more important to global growth as the manufacturing sector makes up just below 16% of global GDP growth. This is not a surprise given that employment remains strong and is around pre-crisis lows, having fallen steadily over the past decade.

A global recession may still occur. Based on the pre-2009 International Monetary Fund (IMF) argument that a global annual real GDP growth rate of 3% or less was ‘equivalent to a global recession’. Indeed, the IMF’s prediction of 3.3% for 2019 is not much higher than the 3% mark, whilst the World Bank is already expecting a global recession with its forecast at 2.6% for the year. Post April 2009 however, the IMF now defines a global recession as ‘a decline in annual per-capita real World GDP’.

With central banks remaining accommodative, promising ‘insurance cuts’, and many emerging markets still posting strong growth especially China, the world’s second largest economy, with its recent growth at 6.2% and still possessing many levers to stimulate, it is hard to see ‘a decline in annual per-capita real World GDP’ occur at this time. However, if one was to occur, it would likely stem from the U.S. as it continues to hold the largest influence over business and investment sentiment.

Source: New York Fed

As the chart above shows, the probability of a U.S. recession is now almost 33% and is at a level that has historically preceded all other recessions apart from one false signal in 1967. This is no surprise considering the leading indicators such as the falling transportation index and PMIs which has pushed the U.S. Federal Reserve to turn dovish and is on the verge of providing rate cuts in order to steer the economy away from recession.

Bond markets have now started to respond and look to be tapering the chances of a recession as seen in the steepening of the yield curve. Equity markets seemed to have never believed in the chances of a recession as the headline Dow Jones, S&P and Nasdaq indices maintained a steady uptrend over the past couple of months. Global valuations for most assets are above historical averages and caution is warranted, but it looks like risk assets will continue to climb the wall of worry until a recession is within touching distance. Therefore, investors should remain invested but be on the lookout for signs of further deterioration in the global economy and for external shocks such as another breakdown in trade negotiations.

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This month’s perspective highlights that market sentiment on all asset classes is constantly changing. It is important for us to quickly recognise any threats, to preserve your investment capital or to identify early investment opportunities to maximise any return advantages. At Partners Wealth Group we don’t get complacent with the current state of play and constantly monitor investments and your portfolios.

If this article has raised questions regarding your personal situation, please contact your Partners Wealth Group advisor directly or on 1800 333 143.

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