As investors grapple with another bout of market volatility, a batch of mostly subpar economic data—plus media’s grim reaction—are seemingly stoking fears of slowing global growth. In our view, these worries overlook generally strong fundamentals and typify currently dour sentiment.
Last month, Germany, Switzerland and Sweden released GDP reports showing Q3 contractions (oddly, all clocked in at -0.2% q/q).[i] This month, revised Italian and Japanese GDP figures put Q3 growth lower—notching -0.1% q/q (down from +0.1%) and -0.6%, respectively. IHS Markit’s Eurozone Composite Purchasing Managers’ Indexes (PMIs) also weakened in November—52.7, versus October’s 53.1—while Italy’s manufacturing gauge slipped below 50, the line dividing expansion and contraction. Headlines declared Italy is “teetering on recession”[ii] and eurozone growth is “set to remain weak.”[iii]
Across the Channel, media hyped weaker UK PMIs—including the worst Services reading since July 2016—and a trio of flattish monthly GDP reports showing rolling 3-month growth decelerated to 0.4% in August – October (versus 0.6% in July – September).[iv] Media proclaim a “virtual standstill” in the UK economy,[v] while the chief economist at IHS Markit (which conducts UK PMI surveys) described it as “flatlining,” warning, “unless demand revives, a slide into economic decline at the turn of the year is a distinct possibility.”[vi]
We agree, the reports aren’t great. But this doesn’t mean a global recession awaits, in our view. For starters, one-off factors played a role in some of the GDP misses. In Germany and Italy, compliance with new EU-wide auto emissions testing rules slowed production—a hurdle that also contributed to the UK’s slowdown. Similarly, weak Swedish household consumption seems tied to country-specific policy: namely, a new carbon tax, implemented July 1. Data show a jump in June sales preceded a steep July drop—a classic pattern new taxes often drive as consumers front-run them. Meanwhile, natural disasters in Japan—which caused mass power outages and temporarily shut down a major airport—dented Q3 growth there.
Moreover, GDP is backward-looking—and “synchronized” growth isn’t necessary for stocks to rise. Different economies have different drivers—which may surge or fade from time to time without endangering global growth. One country falling into recession doesn’t foretell doom for the rest of the world. Italy, for example—where recession chatter is loudest—is just 2.5% of the global economy, per 2017 IMF figures. Japan—two and half times Italy’s size—endured recessions in 2011 and 2014 without dragging down the rest of the world.
While UK and eurozone PMIs don’t impress, they aren’t as dire as many portray, in our view. Despite ticking down in November, they still showed the majority of firms expanding. A slimmer majority, but extrapolating a recession from this (in Italy or elsewhere) strikes us as speculative: Even contractionary PMIs don’t automatically foretell a downturn. PMIs measure growth’s breadth—how many firms grew—not its magnitude (by how much). PMIs could contract while output grows, if the firms that grew did so rapidly—see Italy in October, when the contractionary PMI didn’t match manufacturing output’s 0.2% m/m growth. Similarly, an expansionary PMI could occur despite output actually contracting, which happened with UK manufacturing in October. Hence, beware direct conclusions about output drawn from breadth measures. That said, PMIs are volatile and bounce around plenty during expansion, including this one. Besides the UK’s post-Brexit PMI slide, US manufacturing PMIs dipped below 50 from October 2015 – February 2016 as the energy industry struggled.[vii] Yet a recession didn’t follow in either case.
Slipping business confidence—the worst since August 2016 for the eurozone and July 2016 for the UK—was a big contributor to November’s PMI disappointments, but it isn’t a reliable leading indicator. Purchasing managers are people, too—they may be reacting to recent economic news, market volatility or prevailing fears. Businesses’ new orders are more telling, as they (imperfectly) foretell tomorrow’s production. November PMIs indicate these dipped but remained expansionary in the eurozone and UK—a silver lining we see few emphasize.
Beyond new orders, forward-looking lending and money supply measures out of the UK and eurozone have been growing for years. Although broad UK money supply and business loan growth have slowed from their respective early-year paces of 5.2% and 4.5% y/y, both remain positive.[viii] In October, lending grew 2.6% y/y and money supply 3.4%.[ix] In the eurozone, broad money supply and business loan growth both hit 3.9% y/y in October.[x] The former has hovered around 4% for much of this year, while the latter has risen choppily since emerging from negative territory in September 2015.[xi] This signals credit is flowing to businesses and consumers—telling evidence the UK and eurozone economies aren’t on the rocks. And while many make much of Italy’s contractionary Manufacturing PMI, few paid heed to its gauge covering the much-larger Services industry, which hit 50.3 in November. Alongside growing manufacturing output, this suggests Italy may be in better shape than widely appreciated.
In our view, present dour expectations—which recent coverage of weak data reflects and contributes to—are baked into stock prices. After all, stock markets are highly efficient, swiftly pricing in headline fears. Hence, we believe present recession worries boost the likelihood even modest future growth proves a positive surprise.
[i] Source: FactSet, as of 12/10/2018.
[ii] “Italy Tries to End Budget Fight With EU as Economy Teeters on Recession,” Giovanni Legorano and Paul Hannon, The Wall Street Journal, 12/5/2018.
[iii] “Eurozone Growth Set to Remain Weak as Italy Recession Looms,” Piotr Skolimowski, Bloomberg, 12/5/2018.
[iv] Source: Office for National Statistics, as of 12/10/2018.
[v] “Economy at virtual standstill as construction and manufacturing output shrink,” Tim Wallace, The Telegraph, 12/10/2018.
[vi] Source: IHS Markit, as of 12/10/2018.
[vii] Although oil drilling and mining fall within the Institute for Supply Management’s US non-manufacturing PMI, the manufacturing gauge includes the Petroleum & Coal Products industry, where many oil refiners reside.
[viii] Source: Bank of England, as of 12/6/2018. M4 money supply and M4 lending (excluding intermediate other financial corporations) for January 2018.
[ix] Ibid. M4 money supply and M4 lending (excluding intermediate other financial corporations) for October 2018.
[x] Source: European Central Bank, as of 12/6/2018. M3 money supply growth and adjusted loans to non-financial corporations for October 2018.
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