China isn’t the only country slowing, as we are sure you’ve all been hearing, the global economy is slowing to a level that ought to make everyone pay attention. Earlier this month the International Monetary Fund (IMF) cut forecasts for 2015 yet again, projecting 3.1% versus its prediction in July for 3.3% and its April prediction for 3.5%. This means that this year, despite the unprecedented level of monetary stimulus injected all over the world by government desperate to get things moving… the world economy will grow at its slowest pace since the global financial crisis.
Last week, Citibank cut its global growth forecast for 2016 for the fifth consecutive month, predicting 2.8% versus the previous forecast of 2.9%. Keep in mind that Citibank’s chief economist William Buiter has stated previously that global growth below 3% coupled with a significant output gap effectively represents a global recession. Now that’s just one person’s opinion, but it conveys the importance of these numbers.
If we take a brief tour around the globe, we’ll see that the Eurozone in 2014 finally posted positive growth of 0.9%, after having contracted in 2012 and 2013. The first quarter’s growth rate came in at 0.5% with the second quarter slowing slightly to 0.4%, giving the economy about 1.2% growth year-over-year.
In mid-November, we’ll get the first estimate for the third quarter, which so far is likely to be at around the same pace as the second. On Friday, we got some good news when the Eurozone Markit Composite PMI (Purchasing Manager’s Index) came in at 54 (above 50 is expansionary). The data for services came in nicely at 54.2 with manufacturing unchanged from the prior month at 52. So there is some growth in the region, though from a historical perspective it is still relatively weak. So let’s dig into the details.
If we dig a bit deeper, we see that the Eurozone’s largest economy, Germany, is suffering from the slowing in China and Russia, two major export partners with its 2nd quarter GDP coming in at 0.4%. Consumer confidence has been falling since the first quarter, but it still maintains an enviable unemployment rate of less than 5%, with a youth unemployment rate of 7%, which bodes well for the nation’s productivity in the future.
France, the Eurozone’s second largest economy, on the other hand experienced no growth in the second quarter, versus expectations for a 0.2% increase with an unemployment rate of just under 11% and a youth unemployment rate of nearly 25%.
Italy, the Eurozone’s third biggest economy experienced just 0.2% growth versus 0.3% expected. Unemployment has remained stubbornly high at nearly 12% with youth unemployment over 40%, which is a devastating number for the future of the country. However, Prime Minister Matteo Renzi has made a lot of progress in reforming the government, so despite those rather dour numbers, consumer confidence is higher today than it has been over the past 12 years! Directions are important – we can’t just look at the numbers in isolation.
So things aren’t great in Europe, but they aren’t horrible either… however, significant growth seems perpetually illusive with rising concerns that the slowing in China and the emerging markets could be a tipping point for the area, which is likely why the head of the European Central Bank, Mario Draghi, hinted last Thursday that the ECB (Europe’s version of the Fed) is willing and ready to inject more quantitative easing into Europe’s economy. More QE, the now omnipresent heroin of the stock market was promised and equity indices all over soared!
So what about China? How bad it is there? Truth is, no one really knows. The country is based on an ideology that requires opacity at all levels of government, so accurate data or even an honest attempt at accurate data is something we are unlikely to ever get from official sources.
Those sources recently reported that China’s growth in Q2 was 6.9%, close enough to the official target of 7.0%, but being below, it provides a wee bit of cover for some stimulus. And wouldn’t you just know it! The People’s Bank of China, essentially their Fed, just lowered lending rates…a coincidence we’re sure!
Taking a step back, China has cut their 1-year interest rate 6 times since November of 2014, lowering the rate from 5.6% to 4.35%… but we’re sure everyone there is quite calm! The Required Deposit Reserve Ratio for Major Banks has been lowered 4 times since February, from 19.50% to 17.50%. This ratio determines how much leverage banks can have, which translates into loans. The lower the ratio, the greater the leverage which means more loans… more of nothing to see here folks? We don’t think so.
Here are a few more interesting data points:
- China’s export trade has fallen -8.8% year to date.
- China import trade is down 17.6% year to date.
- Railway freight volume is down 17.34% year over year.
- China hot rolled steel price index is down 35.5% year to date
- Fixed asset investment is up 10.3% sounds great? (averaged +23% 2009-2014)
- Retail sales are up 10.9%, the slowest growth in 11 years
- China Containerized Freight Index, which reflects the contractual and spot market rates to ship containers from China to 14 destinations around the world, has just hit its lowest level in history, now 30% below where it was in February and 25% below where it was at its inception 17 years ago.
You get the point. It is slowing and we suspect it is slowing a lot more than the official GDP numbers would indicate.
Why should those of us outside China care? Because China has been a major supporter of global growth since the financial crisis. When all hell broke loose in 2007 & 2008, China put its infrastructure spending into high gear. That meant that those economies that supply commodities had a backup buyer for their exports when everyone else was crashing, which put a vital floor under the global economy.
But China couldn’t keep it up indefinitely, and we are seeing the consequences of that nation’s shift from a primarily export driven, massive infrastructure-building economy to a more domestic demand-driven economy with a lot less infrastructure spending.
China has been Germany’s fourth-largest export partner, with Russia not that far behind. Falling oil prices and sanctions have crippled Russia’s economy, so it also isn’t buying much from Germany. If Germany sells less, it’ll buy less from other nations… and keep in mind that all those Eurozone countries are just barely eking out positive growth, so small changes will have an impact.
Onto those emerging economies, many of which were benefiting from China’s infrastructure spend as they are primarily commodity exporters. If we look at what has happened to commodity prices over the past twelve months, you can get an appreciation for just how painful this has been for many of these countries. Keep in mind that 45% of global GDP comes from commodity export nations – commodity prices crater and these nations can buy less stuff from other nations – more headwinds to growth.
In fact, 2015 will be the fifth consecutive year that average growth in emerging economies has declined. This is a serious drag on the advanced economies, which on the other end of the spectrum, will likely post their best growth since 2010 – albeit growth that isn’t all that spectacular.
Japan… well it’s still stuck between barely growing and contracting, regardless of how much the Bank of Japan tries to kick start the economy. Japan’s industrial output unexpectedly fell in September, raising concerns that the nation may be slipping back into another recession. Production declined 0.5% in August following a 0.8% decline in July versus economists’ expectations for a 1% gain. Inventories rose 0.4% in August over July, and expanded in five of eight months this year, which is a hindrance to future growth as with rising stockpiles of unsold goods, companies are less likely to expand output in the future.
As for Latin America, Argentina is still a mess and Brazil is in a recession, with many of the other countries doing alright. Chile is expected to be around 2.5% for 2015. Colombia 2.8%… like we said, ok, not great.
In the US, things aren’t awful, but not exactly robust, which is why I had been predicting for months that the Fed would not hike rates in September.
- For example, the Industrial production index came in with another decline of -0.4% in September versus expectations of -0.2%, which makes it the 5th decline out of 8 reported figures in 2015.
- Capacity utilization, which measures to what degree the economy is taking advantage of its ability to make stuff, was expected to drop from 78% to 77.8%. Instead, it fell further to 77.6%, for the 7th decline out of 8 readings in 2015. This means the U.S. continues to use less and less of its capacity to make stuff – hardly shocking given the wide misses in manufacturing data reported by regional Federal Reserve banks for August.
- September retail sales came in below expectations, rising a seasonally adjusted 0.1% from August versus expectations for 0.2%. The good news is the increase came from a 1.8% month-over-month increase in auto sales. Overall retail sales, when we exclude autos and gasoline, have not grown since January.
- U.S. producer prices in September posted their biggest decline in eight months, at a drop of -0.5%, as energy costs fell for the third month in a row. This means that the Producer Price Index is now down 1.1% year-over-year as of the end of September.
- U.S. total business sales also declined in September, down -0.58% month-over-month and down -3.09% year-over-year as of August.
Going forward, I still remain very skeptical that the Fed will raise rates. The fact that China is continuing to loosen its monetary policy and comments out of the ECB concerning it likely embarking on further easing only add to our skepticism as the moves by China and the ECB will already put upward pressure on the dollar, harming U.S. exports. A rate hike would only exacerbate the dollar strengthening against other currencies.
Fed tightening has been a trigger in nine of the last eleven recessions, so you can see yet another reason for the Fed to be cautious.
The tough thing now is that with a Fed that can’t seem to make up its mind, investors are left wondering what to do, so they end up selling the good and the bad when they get nervous. This will make for increased volatility, but that also means more opportunities for those that keep focused on the goal and don’t get distracted by shorter-term market dramatics.