04 October 2019
Next year will be one of increasing downside risks, despite the best efforts of central banks to prolong the 10-year old global expansion. Looking solely at the performance of financial assets year-to-date (equity and credit spreads), one might believe that central banks have almost unlimited powers to produce economic growth. This high level of confidence by the market is unsurprising given the successive, and highly successful, rounds of monetary intervention since the global financial crisis.
However, even central bankers themselves are beginning to question the extent of their own powers and shifting focus onto fiscal stimulus as the appropriate next phase of macroeconomic policy. In June, the president of the European Central Bank, Mario Draghi, spoke of the need for “recreating fiscal space by raising potential output through reforms and public investment…to maintain investor confidence.” I think it is too optimistic to expect near-term fiscal bazookas; serious spending packages backed by legislative approval in the US and the EU are at best 1-2 years away. Fiscal stimulus will not arrive in time to help 2020 growth.
Meanwhile, global manufacturing, which began to slow down in 2018 but showed some signs of recovery in 2019, appears to be taking a turn for the worse again amid festering trade tensions. The uncertainties created by zig-zagging trade policy has already begun to constrain US business investment and capex; and if the trade war is not put to rest, the next dominoes to fall could be consumer confidence and employment. The pain is already reverberating through export-led markets in Europe and Asia and beginning to be reflected in ISM data in the US.
Over the longer term, financial assets and corporate margins are both at risk, with progressive left political forces gathering steam in the US and the UK. The push for redistribution of wealth and income is also demographically driven, so one could even say that the path of travel is inevitable. The logical outcome of all this is a rebalancing of value between financial asset prices and real economy prices - the divergence can be seen in the chart below. This reversion to the mean may begin as soon as 2020-21 depending on elections in these two countries. The takeaway for investors is that they may hope for the best but should be ready to make a sharp turn in case the party comes to abrupt and untimely end.
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