Macro

“Tell me why Xi should not continue to wait out ‘The World’s Greatest Negotiator’ who keeps ‘dealing with himself’?” An apt comment in hindsight from Jim Chanos in mid-August, a well-known US investment manager and prominent short-seller. After unexpectedly escalating the trade dispute mid-negotiations by announcing new broader tariffs on 1 August, US President Trump seemingly de-escalated matters on 13 August delaying half of them.

Then in response to China’s well-flagged and moderate retaliation of 5-10% tariffs announced on 23 August, Trump again escalated the trade dispute, adding 5% to the US’ multiple tariff tranches. As the late August G-7 meeting in France drew to a close, Trump declared China’s desire to ‘return to the negotiating table’, although there was no confirmation of this from China.

As we noted in our early August Special report Increasing our defensive positioning, we have adopted a more defensive stance in our portfolios, moving underweight equities, reducing some of our underweight in high-grade government bonds, and increasing our defensive positioning in cash. We still believe the underlying fundamentals for the global economy remain solid, reflecting tight global jobs markets, low inflation and very low interest rates. However, we (rightly) judged that China’s new more aggressive negotiating position would portend further escalation in the US-China trade dispute, challenging the ability of the global economy to stabilise this year.

This month we ask if this ‘disruption of the geo-political status quo’, which has put the global outlook on a knife edge, will overwhelm (or just delay) the recent nascent signs of stabilisation in the global economy. To help, we canvass the recent US and domestic equity earnings seasons to see what light companies can shed on the macro economy. While it is too early to tell, our recent Observations piece, Four key signposts for equities, highlights earnings, the health of the global banking system, leading indicators like business conditions and the yield curve as some important signals we will be watching in order for us to engage a more positive portfolio position ahead.

For now, we retain our moderately defensive stance adding a little further to our emerging market equity underweight. There remains the risk that equity markets may ‘give back’ a significant share of their 17% rally in H1 2019 over the coming months ahead of any material (and hopefully sustained) pick-up in global industrial trade and production. Unrest in Hong Kong, a near collapse in the Italian government and rising risk of a hard UK Brexit as new Prime Minister Boris Johnson boldly suspends Parliament, each add to this concern.

August marks another escalation in the trade dispute

The late-June de-escalation in the US-China trade dispute (that has now all but escalated to a war) was remarkably short-lived. We believe the most material development unfolded on 5 August, when China revealed a new more aggressive stance that threatened further escalation. This eventuated through the balance of August, and risks of further escalation remain. 

Signs of global growth stabilisation remain nascent

Recent data suggest growth in the world economy slowed significantly in Q2 to 3.3% from its 4.3% pace just a year ago. The slowdown has been relatively evenly spread across both advanced and developing economies.

As the chart below shows, the outlook for growth remains firm at above 3%, with the International Monetary Fund (IMF) and Organization for Economic Co- operation and Development both forecasting growth to reaccelerate to around 3.5% in 2020. Global growth remains well supported by historically ’easy’ monetary policy and near-universally tight jobs markets (underpinning a modest uplift in wages growth). The US consumer remains robust, China is amid renewed stimulus and domestic growth in Europe and Japan is solid. Australia has likely passed the worst of its housing crisis and recent business investment plans are holding up well.

Yet as we discussed in detail last month, some pick-up in manufacturing and trade activity is critical to the ability of the world economy to stabilise in 2020. While the latest JP Morgan global composite purchasing managers’ index (PMI) has pleasingly rebounded modestly in July, it remains below the critical 52 level that is broadly required to sustain the global economy above a 3% pace of growth. Moreover, UBS recently highlighted the worrying breadth of decline in global PMIs, with 70% of the world’s country level PMIs below the critical 50 mark, compared with only 24% at the start of 2019.

PMIs are still flagging a pull-back in global growth 

Whether the weakness in industrial sectors globally ultimately unravels tight jobs markets, or the latter drives consumers to demand more industrial goods (and a production reacceleration), time will tell. But the risks have increased that the cacophony of geo-political noise could sufficiently crush global business confidence and capex plans, so as to undermine the otherwise strong jobs and consumer sectors that are currently supporting growth and company earnings across the world.

Recent comments at the late August Jackson-Hole US Federal Reserve (Fed) Bank of Kansas central banker ‘talk-fest’ echo these concerns:

  • Fed Chair Powell noted that “trade policy uncertainty seems to be playing a role in the global slowdown and in weak manufacturing and capital spending in the United States,”, acknowledging trade wars hurt the US economy in ways monetary policy cannot fix.

  • Reserve Bank of Australia (RBA) Governor Lowe opined that central bankers can't save the global economy by themselves, and that they have limited capacity to cushion the world from the headwinds of increasing political uncertainty. Lowe said, "political shocks are turning into economic shocks.", a clear risk to the outlook ahead.

What the recent reporting seasons tell us about economies

To help assess the state of the global macro-economy, we canvass the recent US and domestic equity reporting seasons to see what light companies can shed on the underlying state of economies.

Insights from the H1 2019 domestic equity reporting season

Through the August reporting season, the S&P/ASX 200 index fell about 4% from its highs at the end of July. Earnings for the 2019 year more than halved from around 4% to 1.3%. Expectations for year ahead earnings were trimmed by a little over 1% to 6.4% (5.9% ex-resources and banks). From a macro perspective, there are five insights from the reporting season:

Overall, a below-average reporting season reveals some tentative signs of stabilising consumer demand, without any evidence that a steadier housing sector is as yet positively impacting underlying activity. A lack of pricing power that has underpinned a strong focus on cost control and protecting margins resonates with the low inflation and falling interest rate environment. The latter is likely delivering both a difficult environment for the financial sector, while also potentially denting economy-wide investment intentions. 

A pick-up in EPS growth is strongest for resources 

Insights from the Q2 2019 US equity reporting season

The S&P 500 index fell about 1% in August and is around 3.3% below its late July high. Through reporting season, one-year forward EPS growth estimates declined moderately from 4.2% in June to around 2.5% now. This compares with around 20% at the end of last year. Significantly, forward earnings before interest and tax (EBIT) estimates are now in negative territory at -0.5%. From a macro perspective, there are five insights from the reporting season: 

Overall, the Q2 reporting season reveals a US economy that is reasonably firm, but one that has slowed. Conditions have clearly become more difficult, particularly for those importing inputs, while exporters have clearly fared less well than domestically focused companies who have benefited from a solid domestic US economy, particularly the consumer. The negative earnings growth also flags the risk that there is more slowing in the economy ahead.

Number of companies citing ‘tariffs’ on earnings calls 

Staying moderately defensive, with a constructive outlook

We have typically labelled pull-backs in risk over the past couple of years as buying opportunities. For now, the escalation in the trade dispute (amid many other geo-political hotspots), leaves us pivoting more defensively so we can assess developments ahead (and trimming further emerging markets, the most exposed equity region). The risk to equity earnings now appears to be to the downside, with US and European earnings flat, and earnings contracting in Asia. The risks to a re-acceleration in 2020 global growth have also risen in the wake of the recent incremental tariff increases. Momentum in company earnings and global PMIs will be key signposts in the months ahead.

Nonetheless, we continue to believe President Trump desires both a strong economy and a trade deal ahead of the November 2020 presidential election, and the rising noise in the US about a recession as the yield curve inverts may accelerate a trade de-escalation sooner than expected. Events in the UK surrounding Brexit are coming to a head and may deliver a clearer picture by the end of next month. While global monetary policy is reaching its limits, there is also the prospect of renewed fiscal support for growth aiding a number of regions, particularly Germany, the US, China and Australia. 

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