Key points

  • With the “policy put” in place (dovish US Federal Reserve and European Central Bank, fiscal stimulus in China and Eurozone), we have been waiting for signs of a cyclical upswing…
  • … getting us to focus on China and Asian trade; both point to the slowdown bottoming out.
  • This is good news for the Eurozone where the sequential improvement has been very modest so far.
  • US GDP should slow for the third consecutive quarter, partly on temporary factors. Still, our US recession probability model has been worryingly nearing its relevant threshold
  • This macro backdrop leaves us with a modest but rising risk appetite, especially in spread product (US High Yield and emerging market debt) amid the renewed trend of lower global rates

World trade and Chinese slowdowns bottoming out

Earlier this month, we outlined that the “policy put” was in place, from the US Federal Reserve (Fed) downgrading its “dots” and announcing the early end of its balance sheet unwind, to the European Central Bank (ECB)’s renewed dovishness in the extension of its forward guidance. Adding the significant Chinese fiscal stimulus (worth more than 2% of GDP) and the more modest fiscal boost in various Eurozone member states, the stage was set for a sequential economic acceleration.

As the main source of this slowdown came from Asian trade and China, we focus in this Monthly Investment Strategy on tracking these, developing new indicators to complement our toolkit. First, our China Economic Cycle Indicator (ECI) adjusts and combines several activity metrics which exhibit similar cyclical trend at odds with the extreme stability of official GDP growth data. The ECI captures the underlying trend in China’s domestic demand and tracks well the fluctuations in Chinese imports and corporate earnings. This indicator confirms that Chinese activity has undergone significant deceleration since 2017, similar to that seen in 2015. Looking forward, early indicators are consistent with Chinese demand bottoming out in the next few months. These include a rise in lending since January – reflecting Chinese stimulus – which historically has preceded an upturn in activity by about six months. This is reassuring as, even though China’s real GDP growth surprised on the upside in the first quarter of 2019 (at 6.4% year-on-year), Chinese imports are still contracting sharply.

Second, we introduce our Asian Export Monitor (AEM) which adds to our toolkit of world trade trackers by focusing on emerging Asia. The AEM combines early signals from trade monthly flows of key countries which have recently posted signs of improvement. Here again, the AEM hints at a probable bottoming of Asian export growth.

Eurozone to follow whilst US modestly slows

Current global trade weakness explains subdued readings in global industrial output and manufacturing surveys, including some of the most recent US business surveys. As the consensus view on Eurozone macroeconomics was very hopeful (in terms of timing and magnitude), the latest European business surveys came in below consensus expectations. To date the sequential improvement has been very modest. An improvement in Asian activity and global trade should support industrial indicators over the coming quarters. More importantly, business confidence has remained elevated in services, dissipating fears of a contagion of the past manufacturing slowdown.

Meanwhile, the US economy looks set to slow for the third consecutive quarter, at around 1.5% annualised in the first quarter of 2019. We however see this to prove partly temporary with retail and government spending rebounding to support the second quarter (Q2) – around 2.5% – and with some residual
seasonality also persisting. Altogether, our US recession probability model falls short of its relevant threshold over the next twelve months, but the margin has been shrinking and we still see US GDP growth below potential next year, at 1.6% (vs. consensus at 1.9%).

Asset Allocation: risk appetite modest but on the rise as spread product carry attractive

True to form, risky markets have been prompted in pricing a bottoming-out in of global growth following the synchronised slowdown of the last twelve months. US stock indices have been reaching new all-time highs, as price/earnings (PE) ratios have risen to reflect a dovish Fed/lower yields and Q1 earnings have held up reasonably well (as reported so far). Credit markets too continue to trade constructively after record breaking Q1 performance – eg US High Yield (HY). Oil, Chinese stocks and Euro bank stocks lead the pack in terms of year to date returns across assets.

This overall backdrop leaves us with a risk appetite that is modest but rising, in spread product in particular – US HY and emerging market (EM) debt – amid the renewed trend of lower global rates. Within equities we direct our overweight in EM and euro banks, where the rebound in valuation multiples year to date has lagged in comparison to US stocks. We maintain a neutral stance in terms of duration exposure amid global fixed income. This is a prudent stance while we navigate a potential turning point in global growth where more prove signals are required before turning cautious on duration.


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