Global Growth On Track or Derailed?
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1 Austin Pickle, CFA Investment Strategy Analyst WEEKLY GUIDANCE ON ECONOMIC AND GEOPOLITICAL EVENTS Global Growth On Track or Derailed? Key takeaways May 15, 2018» Concerns regarding the global growth outlook have increased recently due to tariffs, sanctions, geopolitical tensions, market volatility, and some disappointing economic readings.» While recent events certainly bear monitoring, we believe that the global economy is healthy. We expect accelerating U.S. economic growth and steady global growth in What it may mean for investors» This positive economic growth outlook should provide a strong foundation for continued earnings improvement and equity returns, while periodic volatility can offer attractive opportunities to bring equity allocations to their targets.» The rising rate environment, and the narrowing difference between interest rates at different maturities (as the Treasury yield curve has flattened), reinforces our preference for shorter-term fixed income investments that are broadly diversified. Investor sentiment has changed abruptly in In 2017, the markets were focused on U.S. tax reform, significantly higher corporate earnings forecasts, and expectations for increased consumer, business, and infrastructure spending. Among other, persistent improvements in 2017, these economic tailwinds had created an optimistic consensus outlook for accelerating, and synchronized, global growth in Fast forward a few months, and investors now are facing headlines about tariffs and sanctions, escalating Middle East tensions, equity market volatility, concerns over interest rates rising too quickly (after being subdued for years), and a few economic report disappointments. These developments seemingly have dampened the optimistic global growth outlook. In today s report, we will answer the question, Is the global growth trajectory still intact? The global economy remains healthy In the face of some unsettling recent events, it may be easy to lose sight of the fact that the positive economic outlook that prevailed at the end of 2017 remains intact. Our forecasts show that we believe the robust U.S. and global economic expansion will continue in 2018 (Table 1) Wells Fargo Investment Institute. All rights reserved. Page 1 of 6
2 Table 1. Historical GDP growth and 2018 forecasts Global economy Region 2018 year-end targets U.S. GDP growth 2.9% 2.3% 1.5% Developed-market GDP growth 2.3% 2.3% 1.7% Emerging-market GDP growth 4.7% 4.8% 4.3% Global GDP growth 3.7% 3.8% 3.2% Sources: FactSet, Bloomberg, International Monetary Fund, Wells Fargo Investment Institute (WFII), May 9, Year-end 2018 target is WFII s forecast. Forecasts are based on certain assumptions and on views of market and economic conditions which are subject to change. How can we be so confident that the global expansion is not set to falter? When you wade past the headline noise, it is quite clear that the actual data continues to support a continued global expansion. To illustrate this point, we created Table 2, which shows the current value, quarterly change, and year-over-year change in a number of global economic activity and sentiment indicators. Those shaded in green support growth, while those shaded in red indicate weakening growth. Notice how both the current values and the year-over-year change columns are almost entirely green. In other words, the vast majority of indicators confirm that the global economy is expanding and that the long-term economic trends are improving. Table 2. Global economic health scorecard Indicator Global economic health Quarter-over-quarter Current value change Year-over-year change Global real GDP* 3.5% Global unemployment rate* 5.2% Global composite leading indicator* Industrial production World trade volume Container shipping rates Raw material shipping rates Global house price composite Global business sentiment* Global manufacturing sentiment* Global services sentiment* Percent of countries with expansionary manufacturing sentiment readings* 88.6% IFO world economic climate index* Citi global economic surprise index* Sources: Bloomberg, International Monetary Fund (IMF), Organization for Economic Co-operation and Development (OECD), Markit, Ned Davis Research Group, CPB Netherlands Bureau for Economic Policy Analysis, Hamburg Shipbrokers Association, Baltic Exchange, IFO Institute, Citigroup, Wells Fargo Investment Institute. * Designates changes measured as point change rather than percentage change. Global unemployment rate is measured by the OECD area unemployment rate. The global composite leading indicator is measured by the OECD plus leading indicators of six nonmembers. Global business, manufacturing, and services sentiment measures are represented by the Markit Global Composite, Global Manufacturing and Global Services Purchasing Managers Indices (PMIs), respectively. Container shipping rates represented by the ConTex Index. Raw material shipping rates represented by the Baltic Dry Index. As of May 9, Wells Fargo Investment Institute. All rights reserved. Page 2 of 6
3 Taking a closer look Table 2 does reinforce our positive outlook on the global growth story. Yet, there are a few short-term trends that we would like to address notably, the soft quarterly business, manufacturing, and services sentiment indicators and the negative Citi Global Economic Surprise Index (surprise index) readings. Let s first review the surprise index. This index measures economic forecasts and compares them to actual data. A positive surprise is when the actual data is better than forecasted (and a negative surprise is when it is worse). We believe that the current negative surprises are reflective of sentiment that has risen faster than the positive economic trend. In an economy in which activity is accelerating, positive sentiment frequently overshoots, so negative surprises likely are not signaling worsening conditions. We do not believe that the surprise index values are a source of concern. To determine the regional source of the weak surprise index readings, we created Table 3. Table 3 deconstructs the global surprise index into three regions: the U.S., developed markets, and emerging markets. Developed markets have been the main detractor from the surprise index measures. Expectations may have been too high for the area after such a strong finish last year. Table 3. Surprise indices by region Regional Citi Economic Surprise Indices Index Current value Quarter-over-quarter change Year-over-year change United States* Developed markets* Emerging markets* Sources: Bloomberg, International Monetary Fund (IMF), Organization for Economic Co-operation and Development (OECD), Markit, Ned Davis Research Group, CPB Netherlands Bureau for Economic Policy Analysis, Hamburg Shipbroker's Association, Baltic Exchange, IFO Institute, Citigroup, Wells Fargo Investment Institute. *Designates changes measured as point change rather than percentage change. Global unemployment rate is measured by the OECD area unemployment rate. Global composite leading indicator measured by the OECD plus 6 non-member leading indicator. Global business, manufacturing and services sentiment are the Markit Global Composite, Global Manufacturing and Global Services PMI indices respectively. Container shipping rates represented by the ConTex Index. Raw material shipping rates represented by the Baltic Dry Index. Business sentiment also is worth noting. All three measures of business sentiment (composite, service, and manufacturing) weakened during the first quarter. Two of the three measures now are flat on an annual basis. It is important to remember, though, that all three are still showing readings above 50, which indicates economic expansion. In other words, business sentiment may not be exuberant, but it remains positive. Another encouraging sign is the impressive breadth of global manufacturing industry sentiment strength. With roughly 90% of manufacturing sentiment in expansion territory, essentially, all world economies are contributing Wells Fargo Investment Institute. All rights reserved. Page 3 of 6
4 Table 4. Business sentiment by region Regional business sentiment indicators Indicator Current value Quarter-over-quarter change Year-over-year change U.S. business sentiment* U.S. manufacturing sentiment* U.S. services sentiment* Developed markets business sentiment* Developed markets manufacturing sentiment* Developed markets services sentiment* Emerging markets business sentiment* Emerging markets manufacturing sentiment* Emerging markets services sentiment* Sources: Bloomberg, International Monetary Fund (IMF), Organization for Economic Co-operation and Development (OECD), Markit, Ned Davis Research Group, CPB Netherlands Bureau for Economic Policy Analysis, Hamburg Shipbroker's Association, Baltic Exchange, IFO Institute, Citigroup, Wells Fargo Investment Institute. *Designates changes measured as point change rather than percentage change. All in all, the vast majority of global economic sentiment and activity measures confirm that the global economic expansion remains on track. We would only become concerned about new potential downtrends if we were to see weakness across a broader collection of indicators. Investment implications We believe that recent events have distracted from, but have not derailed, the robust global expansion. Continued economic growth should provide a solid foundation for earnings and equity markets in general. With the support of tax reform, and stronger economic trends, U.S. equity markets appear best situated to capitalize upon the growth story. We expect earnings improvement to possibly drive positive returns in both developed markets (ex-u.s) and emerging markets, but tariff talk increases the downside risks (more so for emerging markets than for developed markets ex-u.s.). We currently have a favorable rating on U.S. equities, a neutral rating on developed markets (ex U.S.) equities, and an unfavorable rating on emerging market equities. Periods of equity-market volatility can provide attractive opportunities for investors to bring allocations to recommended target weights. As we continue through the domestic business cycle, we expect inflation (and the fed funds rate) to rise gradually. This trend will affect fixed-income markets, as inflation has negative implications for longer-term bond yields (and prices), while a rising fed funds rate implies rising short-term rates. This dynamic decreases the appeal of longerterm bonds while increasing the attractiveness of shorter-term issues (which generally have lower interest-rate risk, or duration, risk). As a result, we have a most unfavorable rating on U.S. long-term taxable fixed income and a favorable view on U.S. short-term taxable fixed income. We are unfavorable on fixed-income developed markets outside of the U.S., due to unattractively low yields and poor risk/return profiles. While the economic expansion is supportive of commodity demand, this asset class remains largely oversupplied. We expect lower commodity prices by year-end 2018 and have an unfavorable rating on the asset class Wells Fargo Investment Institute. All rights reserved. Page 4 of 6
5 Economic Calendar Date Report Estimate Previous 5/14/2018 Mortgage Delinquencies % 5/14/2018 MBA Mortgage Foreclosures % 5/15/2018 Empire Manufacturing /15/2018 Retail Sales Advance MoM 0.40% 0.60% 5/15/2018 Retail Sales Ex Auto MoM 0.50% 0.20% 5/15/2018 Retail Sales Ex Auto and Gas 0.40% 0.30% 5/15/2018 Retail Sales Control Group 0.40% 0.40% 5/15/2018 Business Inventories 0.20% 0.60% 5/15/2018 NAHB Housing Market Index /15/2018 Total Net TIC Flows -- $44.7b 5/15/2018 Net Long-term TIC Flows -- $49.0b 5/16/2018 MBA Mortgage Applications % 5/16/2018 Revisions: Housing Starts 5/16/2018 Housing Starts 1325k 1319k 5/16/2018 Housing Starts MoM 0.30% 1.90% 5/16/2018 Building Permits 1350k 1354k 5/16/2018 Building Permits MoM -2.10% 2.50% 5/16/2018 Industrial Production MoM 0.50% 0.50% 5/16/2018 Manufacturing (SIC) Production 0.60% 0.10% 5/16/2018 Capacity Utilization 78.40% 78.00% 5/17/2018 Initial Jobless Claims 218k 211k 5/17/2018 Continuing Claims k 5/17/2018 Philadelphia Fed Business Outlook /17/2018 Bloomberg Economic Expectations /17/2018 Bloomberg Consumer Comfort /17/2018 Leading Index 0.40% 0.30% 5/21/2018 Chicago Fed Nat Activity Index /22/2018 Richmond Fed Manufact. Index Source: Bloomberg, as of May 11, Wells Fargo Investment Institute. All rights reserved. Page 5 of 6
6 Risk Considerations Each asset class has its own risk and return characteristics. The level of risk associated with a particular investment or asset class generally correlates with the level of return the investment or asset class might achieve. Stock markets, especially foreign markets, are volatile. Stock values may fluctuate in response to general economic and market conditions, the prospects of individual companies, and industry sectors. Foreign investing has additional risks including those associated with currency fluctuation, political and economic instability, and different accounting standards. These risks are heightened in emerging markets. Bonds are subject to market, interest rate, price, credit/default, liquidity, inflation and other risks. Prices tend to be inversely affected by changes in interest rates. The commodities markets are considered speculative, carry substantial risks, and have experienced periods of extreme volatility. Investing in a volatile and uncertain commodities market may cause a portfolio to rapidly increase or decrease in value which may result in greater share price volatility. Definitions Purchasing Managers Indexes (PMI) are indicators of the economic health of the manufacturing sector, services sector and economies as a whole of the countries or regions noted. The PMI index is based on: - Manufacturing: Output, new orders, new export orders, backlogs of work, output prices, input prices, suppliers delivery times, stocks of finished goods, quantity of purchases, stocks of purchases, employment, future output. - Services: Business activity, new business, backlogs of work, prices charged, input prices, employment, expectations for activity. - Composite: Output, new orders, new export orders, backlogs of work, output prices, overall input prices, purchase prices, staff costs, suppliers delivery times, quantity of purchases, stocks of purchases, employment, future output. A PMI of more than 50 represents expansion when compared to the previous month. A PMI reading under 50 represents a contraction, and a reading at 50 indicates no change. ConTex Index is a Container Ship Time Charter Assessment Index. It is a company-independent index which is calculated as an equivalent weight of percentage change from six ConTex assessments, which are for the classes of Type 1100 TEU, Type 1700 TEU, Type 2500 TEU, Type 2700, Type 3500 and Type The index starting point is New ConTex is compiled by a group of international operating brokers and is updated twice a week. The data source is Vereinigung Hamburger Schiffsmakler und Schiffsagenten e.v. (VHSS), the Hamburg Shipbroker's Association. As of May , ConTex index expanded to include new size ranges (Type 2700, Type 3500 and Type 4250) and was renamed New ConTex. Contex: CTEXIDEX is an actual index which is based at 1,000. An index is unmanaged and not available for direct investment. General Disclosures Global Investment Strategy (GIS) is a division of Wells Fargo Investment Institute, Inc. (WFII). WFII is a registered investment adviser and wholly owned subsidiary of Wells Fargo Bank, N.A., a bank affiliate of Wells Fargo & Company. The information in this report was prepared by Global Investment Strategy. Opinions represent GIS opinion as of the date of this report and are for general information purposes only and are not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally. GIS does not undertake to advise you of any change in its opinions or the information contained in this report. Wells Fargo & Company affiliates may issue reports or have opinions that are inconsistent with, and reach different conclusions from, this report. The information contained herein constitutes general information and is not directed to, designed for, or individually tailored to, any particular investor or potential investor. This report is not intended to be a client-specific suitability analysis or recommendation, an offer to participate in any investment, or a recommendation to buy, hold or sell securities. Do not use this report as the sole basis for investment decisions. Do not select an asset class or investment product based on performance alone. Consider all relevant information, including your existing portfolio, investment objectives, risk tolerance, liquidity needs and investment time horizon. Wells Fargo Advisors is registered with the U.S. Securities and Exchange Commission and the Financial Industry Regulatory Authority, but is not licensed or registered with any financial services regulatory authority outside of the U.S. Non-U.S. residents who maintain U.S.-based financial services account(s) with Wells Fargo Advisors may not be afforded certain protections conferred by legislation and regulations in their country of residence in respect of any investments, investment transactions or communications made with Wells Fargo Advisors. Wells Fargo Advisors is a trade name used by Wells Fargo Clearing Services, LLC and Wells Fargo Advisors Financial Network, LLC, Members SIPC, separate registered broker-dealers and non-bank affiliates of Wells Fargo & Company. CAR Wells Fargo Investment Institute. All rights reserved. Page 6 of 6
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