WHAT GLOBAL SYNCHRONIZED EXPANSION?

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1 Special Commentary Written by Leo Goldstein WHAT GLOBAL SYNCHRONIZED EXPANSION? LEO GOLDSTEIN Senior Research Analyst JAMES F. KEEGAN Chairman and Chief Investment Officer Seix Investment Advisors is an investment management boutique focused exclusively on managing fixed income securities since Seix seeks to generate competitive absolute and relative risk-adjusted returns over the full market cycle through a bottom-up focused, top-down aware process. Seix employs multidimensional approaches based on strict portfolio construction methodology, sell disciplines and trading strategies with prudent risk management as a cornerstone. INTRODUCTION Economic growth in the developed world has averaged 1.8% since 2011, with several failed attempts at accelerating beyond 2.0% for a sustained period of time. Faster growth would likely have implications for monetary policy implementation. For this reason, it is important for investors, especially in fixed income, to be able to determine if growth is on an accelerated trend to correctly position their portfolios. Every so often, markets get excited about the prospects for faster growth. This year is not different. Many analysts and media outlets have pounded the table on the notion that the global economy has entered a new synchronized expansion not seen since the financial crisis. We analyzed the data to determine the validity of this position. Consensus is building around the notion that economic growth is now synchronized across the globe s largest regions for the first time in many years. The enthusiasm includes the perception that global growth is accelerating robustly. However, the ongoing debate about soft data releases (i.e., survey based) vs. hard data indicates that there is insufficient evidence to conclude that the world economy is on stronger and sounder footing. In this report we address two important issues: 1) Is global growth actually synchronized? 2) If so, is it accelerating? The enthusiasm includes the perception that global growth is accelerating robustly. Our preference is to use gross domestic product (GDP) as the ultimate indicator of economic growth. Many like to point to Purchasing Managers Index (PMI) and Institute for Supply Management (ISM) as good proxies, and at times this data has been useful in analyzing economic trends. But, in a time of heightened political uncertainty and the implementation of extreme monetary policy throughout the world, shifts in sentiment can be dramatic, which can make survey data misleading as it relates to the underlying strength of the economy. Therefore, we think that GDP best captures the state of an economy. PMIs EQUAL EXCITEMENT! Many analysts consider the PMI to be a forward looking indicator. PMIs are constructed from surveying Purchasing Managers in different economic sectors like manufacturing and services. These managers give their assessment on production levels, new orders, speed of supplier deliveries, inventories, order backlogs, and employment levels. A PMI s Composite is a weighted average of the PMI Manufacturing and the PMI Services indices. A reading level above 50 indicates expansion; below 50 means contraction. The vast majority of PMI surveys are carried out by private sector companies such as Markit Group (global) or ISM (in the U.S.). Global PMI Composite Indices have improved from their 2016 level lows, especially in Europe (Figure 1), with Germany being the country with the strongest PMIs within Europe (Figure 2). Global PMIs show a similar story of improvement since mid-2016, but are not higher than in 2014 or 2015, suggesting that global growth is not necessarily more dynamic now than in recent years (Figure 3). FIGURE 1. REGIONAL PMIs COMPOSITE (MARKIT) EUROPE JAPAN FIGURE 2. FRANCE, GERMANY PMIs COMPOSITE (MARKIT) FRANCE GERMANY Past performance is not indicative of future results.

2 Seix Investment Advisors Special Commentary Page 2 FIGURE 3. JPMORGAN GLOBAL PMIs. MANUFACTURING SERVICES COMPOSITE It is difficult to back up statements that growth in the developed world is more synchronized in 2017 than in the last couple of years. Even if this would have been the case, it means little. First, growth remains well within recent ranges. Second, there is no indication that growth in the developed world is accelerating in a sustainable manner. FIGURE 4: GDP GROWTH Q/Q SAAR NOT IN THE GDP NUMBERS False growth signals are not new. Back in 2015, there were arguments that global growth was synchronized for the first time in many years. Some rushed to optimism after Japan and the Eurozone posted very strong growth during 1Q15. The Japanese consumer was simply bringing forward personal consumption ahead of an expected value-added tax (VAT) increase in April of that year. Soon after the VAT implementation, Japanese growth adjusted lower. Eurozone growth at the time was mostly in reaction to a sharp weakening of the euro. Once the euro stabilized, Eurozone growth slowed down, as well. Many believe that strong PMIs suggest a significantly faster pace of growth, but this has not materialized. Despite PMI improvement in the developed world since mid-2016, most recent quarterly GDP releases do not support the optimistic signals of the PMIs. Growth during 1Q17 did not look that much different than in past quarters. Many believe that strong Furthermore, PMIs should be viewed in the context of the potential rate PMIs suggest a significantly of growth. Simply put, a PMI reading faster pace of growth, but this of 58 in a potential growth rate has not materialized. environment of 3.5% is very different than a PMI reading of 58 in a potential growth environment of 1.5%. Our view remains that U.S. potential growth falls somewhere within the 1.5 to 2.0% range. Strong PMIs could lead to one or several quarters of strong GDP growth, but do not alter the trajectory of growth. Our analysis looked at growth data from several different angles to determine if growth is in a lift-off phase. On a quarter-over-quarter annualized basis, growth in the U.S., Japan, and EU has not accelerated to a higher rate in recent quarters (Figure 4). The most simple of growth numbers, the quarter-on-quarter seasonally adjusted GDP numbers, also failed to signal acceleration (Figure 5). Neither could one conclude that growth is accelerating from analyzing 4-quarter accumulated moving averages (Figure 6). Many times, quarterly growth responds to oneoff effects. Overall, it is important to understand the underlying forces prompting a change in the pace of growth to determine if the acceleration is sustainable. Positive changes in labor, capital, or technology are usually necessary to sustain a new faster growth path over the medium term. Structural reform implementation or economic policy changes (monetary or fiscal) could also provide a positive shock to growth. FIGURE 5: GDP GROWTH Q/Q % CHANGE FIGURE 6: GDP GROWTH 4-QUARTER ACCUMULATED MOVING AVERAGE n U.S. n EU n JAPAN EU JAPAN EU JAPAN

3 Seix Investment Advisors Special Commentary Page 3 GERMANY: PMIs VS. GDP There is little indication that CASE STUDY German growth is responding German Purchasing Manager as implied by the optimism Indices have increased at the exhibited in the surveys. fastest pace compared to most other developed countries in the past twelve months. Its Manufacturing PMI has increased 7.5pts to 59.6 since last May and is the second highest in the world (Figure 7). Its Composite PMI has increased 3.6pts to 56.4 since September 2016 and also stands as the second highest in the world. Germany presents a good case study to determine if optimistic survey data is translating into strong GDP growth. German PMIs have been rising since 2Q16, and assuming there is some correlation between PMIs and growth, one would have expected economic growth to start accelerating during 2H16. There is little indication that German growth responded as implied by the optimism exhibited in the surveys. Germany GDP growth has shown no signs of accelerating since the PMIs started their upward trajectory last year (Figure 8). Furthermore, a more detailed analysis of Germany s national accounts could not pinpoint a consistently faster pace of growth in any of the country s GDP components during the past year (Figure 9). FIGURE 8. GERMANY GDP GROWTH Q/Q % CHANGE FIGURE 7: GERMANY PMI MANUFACTURING FIGURE 9. GERMANY GDP ACCOUNTS 1Q16 2Q16 3Q16 4Q16 1Q17 GDP Domestic uses Final consumption expenditure Household final consumption expenditure Government final consumption expenditure Gross capital formation Gross fixed capital formation Gross fixed capital formation in machinery and equipment Gross fixed capital formation in construction Changes in inventory and acquisition less disp. of valuables Balance of exports and imports Exports Imports Source: German Federal Statistical Office

4 Seix Investment Advisors Special Commentary Page 4 JAPAN: THE EXCITEMENT IS Japan s growth has been less WEARING OFF TOO volatile in recent quarters, but Consistent growth acceleration in recent quarters is another it would be more than a stretch consensus narrative used to describe the Japanese economy. As to argue that growth is running consistently faster than in the mentioned above, PMIs have been previous three or four years. rising in Japan since last summer. However, the pace of Japanese growth is not much different relative to previous years (Figure 10). In fact, Japan s 4-quarter moving average growth rate was 0.33% q/q in 1Q17, slower than the 0.4% during Perhaps we can conclude that Japan s growth has been less volatile in recent quarters, but it would be more than a stretch to argue that growth is running consistently faster than in the previous three or four years. FIGURE 10: JAPAN GDP GROWTH Q/Q% CHANGE EMERGING MARKETS: Growth is improving somewhat in LITTLE SURPRISES Emerging Markets, however, most Growth is improving somewhat in Emerging Markets, compared of the growth acceleration is the to the last two years. However, result of statistical bounces rather most of the growth acceleration than real economic improvement. is the result of statistical bounces rather than real economic improvement. First, there is a base effect in play in the calculations since EM growth during 2H15 and 1Q16 was especially hard hit because of China hard landing concerns and sharp commodity price declines. Second, large economies like Brazil and Russia stopped contracting, removing a heavy negative weight. These two economies are expected to only grow around 1% this year. The absence of economic contraction in EM, while a fact, does not result in these economies being significant contributors to the global growth acceleration story. FIGURE 11: EM GDP GROWTH Y/Y% CHANGE WALL STREET FORECASTS DO NOT FORESEE GLOBAL Despite improving Wall GROWTH LIFTOFF Street sentiment about global Despite improving Wall Street growth going forward, street sentiment about global growth going forward, street economic economic forecasts do not forecasts do not reflect this reflect this optimism. optimism (Figure 12). Global growth is expected to be 2.9% in 2017, up only 0.3% from 2016 and is expected to inch up only one additional tenth next year to 3.0%. Developed country growth is expected to rise to 2.0% in 2017 from 1.6% in 2016, pretty much unchanged from the 1.9% in FIGURE 12: GDP GROWTH Q/Q% CHANGE Global Growth DM U.S EU UK Japan Australia New Zealand EM EM Asia China India Indonesia South Korea Taiwan LATAM Mexico Brazil Argentina Venezuela EMEA Russia Turkey Poland Hungary Czech Republic Sources: JPMorgan, Citibank, Credit Suisse

5 Seix Investment Advisors Special Commentary Page 5 RECENT ECONOMIC DATA IS DISAPPOINTING Citi Economic Surprise Indices It is not uncommon for investors to get excited about growth perspectives early in the year. But as has exhibited a downturn in 2Q17. happened more often than not in recent years with the U.S. economy, as the calendar progresses we expect that the economic data will start to undermine the sanguine sentiment toward the global growth outlook. This phenomenon appears to already have begun as indicated by the Citi Economic Surprise Indices, which exhibited a downturn in 2Q17 (Figure 13 and Figure 14). We would expect global growth estimates to be revised somewhat lower in coming months to reflect this reality. FIGURE 13: CITI ECONOMIC SURPRISE INDEX FOR EUROPE AND U.S. EUROPE FIGURE 14:. CITI ECONOMIC SURPRISE INDEX FOR EM AND GLOBAL GLOBAL EM Sources: Bloomberg, Citigroup Sources: Bloomberg, Citigroup THE IMPROVING TRADE CONUNDRUM The only global economic hard data that has seen a real improvement in recent quarters is trade volumes (which faltered significantly in April). It is important to note that the trade improvement was all in the Emerging Markets, with little change in trade patterns in the developed world. Among EM regions, Asia presented the strongest increase, followed by Latin America. Central Europe actually did not show any significant improvements. At this point, it is difficult to know exactly what this temporary improvement means. Perhaps the growth in trade volumes was related to reports that China had been stockpiling resources. The only global economic hard data that has seen a real improvement in recent quarters is trade volumes (which faltered significantly in April). FIGURE 15: GLOBAL TRADE INDEX Source: CPB World Trade Monitor

6 Seix Investment Advisors Special Commentary Page 6 BOTTOM LINE Typically, countries do not suddenly experience accelerated growth rates in the absence of a positive shock. A new impulse, either from structural reforms or a new significant technological change, is required to jump start growth to a higher trend rate. We see no evidence of advancements in either impulse that would warrant a meaningful and sustained growth pick-up going forward. Of course, economies go through swings in the business cycle, and monetary and fiscal policy can be used to boost consumption and investment in order to smooth out the cyclical swings. But, the global economy has been in a malaise since the 2008/09 financial crisis, and global stimulus has been running at full throttle for much of the time since then. It would be highly unusual at this point in the cycle (being at the tail end of the stimulus program), to expect the global economy to suddenly accelerate. Global growth is not more in sync in 2017 than in previous years. Both the developed world and Emerging Markets continue to grow near their recent ranges of 1.6%-2.0% and 4.0%-4.5%, respectively. How do we reconcile the improvement in global PMIs? It is very likely that large swings in sentiment have resulted from important political developments. Political concerns in Europe have eased as nationalist candidates in the Netherlands and France did not win. The abatement of political risk has removed the short term tail risk of the break-up of the EU as well as the deflation scare in parts of Europe. Additionally, China has managed to stabilize its currency through the use of capital controls. Is global growth actually in a synchronized expansionary phase? Global growth is not more in sync in 2017 than in previous years. Both the developed world and Emerging Markets continue to grow near their recent ranges of 1.6%-2.0% and 4.0%-4.5%, respectively. Most importantly, there is little indication global growth is accelerating in a sustainable manner. Like good umpires, we call it like we see it based on data, not narratives. For more information, please contact: Seix Investment Advisors LLC / Tel: / There is no guarantee a specific investing strategy will be successful. Individual investors are advised to consult with their investment professional about their specific financial needs and goals before making any investment decisions. Investment process, strategies, and procedures detailed in this brochure are intended to be general guidelines, subject to market conditions and client-specific investment guidelines and restrictions, and are measured at the time of purchase. Seix Investment Advisors LLC may deviate from these guidelines if market conditions warrant, or if the investment professionals deem doing so would be in clients best interests. Guidelines do not guarantee any reduction of risk or loss. Seix Investment Advisors LLC is an investment adviser registered with the SEC and an affiliate of Virtus Investment Partners, Inc. All third party marks are the property of their respective owners Seix Investment Advisors LLC