The global economic recovery from the COVID-19 pandemic is slowing but the recovery is continuing to progress.
Global growth should slow further but avoid a global recession, while global inflation should continue to fall. This should, all things equal, provide positive support for both equities and bonds over the next 12 months.
While these overarching trends are guiding our view of asset class performance over the coming year, peering under the hood of the global economy shows a more disparate picture that will continue to deliver both volatility and opportunity for investors.
“Benign Disinflation” Remains Our Central Case for the Global Economy
Global growth has held up better than expected this year but still appears to be on a slowing path. At its July update, the IMF moderately upgraded its estimate for global gross domestic product (GDP) growth in 2023 from 2.8% to 3.0%, while keeping its estimate for 2024 unchanged at 3%.
This moderate upgrade to 2023 growth contrasts the view of many commentators at the start of the year that the risk to growth projections were significantly to the downside. While the latest 3% growth estimate for 2023 represents a “better-than-feared” outcome, it still represents a slowdown on the 3.5% growth recorded in 2022 and is below the 20-year average global growth rate of 3.8%.
Arguably, the most positive implication of the current below trend economic growth is that the other great market concern, global inflation, is now decelerating. Inflation is still high in year-on-year (YoY) terms, and sticky core inflation continues to raise concerns that inflation is still a risk, but disinflation does look to be gradually taking hold.
Against this growth and inflation backdrop, central bank tightening has continued through the year. Expectations that policy rates are at or very close to a peak have gained increasing traction, although investors are still debating the risks around central banks’ easing and whether it will come too late or too soon.
The pronounced labour market tightness that has been a feature of this cycle is easing, but only gradually. Unemployment rates have edged slightly higher in some economies, but generally remain close to historical lows. Similarly, job vacancy-to-unemployment ratios have fallen from their early-2022 peaks but remain well above pre-pandemic levels in many advanced economies. Employment growth remains strong, having eased only slightly in many advanced economies over recent months. Both investors and central banks still remain on edge with respect to wage growth outcomes. Our own view is that wage growth will ease as demand cools and headline inflation continues to normalise.
Disparate Economic Momentum Driving Market Volatility
While global growth has been a bit better than expected, it has been uneven in a geographic sense. These cross currents are causing volatility in markets despite the overarching global narrative of moderate global growth and easing global inflation pressure.
US: from hard landing to no landing?
As we discussed last week, US growth has beaten expectations this year and has proven to be way more resilient than the recessionary consensus projections held at the start of the year.
It seems that “no landing” fears have once again overtaken hard landing fears in recent weeks. This has helped drive up bond yields to fresh cyclical highs and helped instigate some recent weakness in US/global equities.
We continue to discount both “hard landing” and “no landing” scenarios for the US. Our view of there being no US recession in 2023 has been based in large part on the observation of a very tight labour market and a consumer still working through a large buffer of excess household savings. Correspondingly, we struggle with the view that the US is set to sustainably reaccelerate given (a) policy tightening always works with a lag and (b) US consumer savings are now close to being run down. So, we expect US growth to slow (but not collapse) over coming quarters, alongside further slowing in inflation and wage growth as demand cools. This should be a reasonably supportive backdrop for both stocks and bonds, all things equal.
Europe: better than feared but not great
Outside the US, the European growth picture has also been better-than-feared this year, although positive economic surprises were front loaded into the start of the year. Growth has been weakening again in recent months, with significant risk that Europe falls into a mild (likely short) recession in the near term. The picture in the major Eurozone economies is mixed. Overall growth in the Euro area is projected to fall, according to the International Monetary Fund (IMF), from 3.5% in 2022 to 0.9% in 2023, before rising to 1.5% in 2024. Given stronger services and tourism, growth has been revised upward by 0.4 percentage points for Italy and by 1 percentage point for Spain. However, for Germany, weakness in manufacturing output means growth has been revised downward by 0.2 percentage points, to a contractionary –0.3 percent.
Looking further ahead, the apparent bottoming of the global manufacturing inventory cycle should support a return to modest growth in 2024 for the Eurozone.
China recovery proving the big disappointment of 2023
In contrast to an upbeat consensus at the start of the year, China has proven to be the biggest disappointment in respect of the global economy for 2023. Although first quarter growth rebounded sharply relative to last year’s Covid lockdown comparatives, more recent growth outcomes have been disappointing. This has led to concerns around the cyclical and structural outlook for the Chinese economy.
Beijing’s 2023 GDP target of 5% was initially seen as a relatively conservative target, which would likely be exceeded. However, the market is now cutting GDP forecasts to sub-5%, as recent trends in property, retail sales, auto sales and other indicators disappoint expectations.
There have been a number of policy initiatives, including some interest rate easing and bringing forward some spending by local governments. However, these measures have been relatively incremental and fallen short of hopes for a game changing stimulus package.
China: Bad News Is Good News, or Bad News is Bad News?
China is battling against an over-indebted housing sector, alongside an excess savings problem within the household sector. We expect additional policy support will be forthcoming, which should improve investor confidence toward China prospects, though the specifics of additional stimulus are still to be clarified.
On the positive side, China does not have an inflation problem (inflation is looking too low, rather than too high) and the central government is not overleveraged. So, we do not see China as posing a significant near-term threat to the global economy.
Commodity Markets Surprisingly Resilient So Far
It is interesting that iron ore prices and, to a lesser extent, the big miners have been relatively resilient in the face of disappointing China data and of stresses in the key property sector. In part, this is likely reflecting the expectation of some further targeted stimulus for the property sector alongside additional infrastructure spending. The resilience in the iron ore price to date also likely reflects the reality that steel production has not been particularly weak so far this year. There is a risk that steel production weakens in coming months, particularly if material stimulus fails to emerge.
From this perspective, specific markets like iron ore do not offer a great risk-return tradeoff in our view, given current prices are already well above our long-term assumptions. We see emerging market (EM) equites as offering a better risk-return tradeoff given valuations are already low.
More broadly, uncertainty around China’s outlook is a risk for global growth, although we see this risk as manageable. Markets generally seem to be relatively calm in respect of China growth headwinds at the moment, with more focus on upside surprise flowing from the US economy.
While China poses risks, we expect a ramp-up in Chinese stimulus measures enabling Chinese growth to at least hit an unspectacular but respectable 4.5% this year and next year.
Longer-term China growth is slowing and growth drivers are shifting. Property is unlikely to be a source of growth over the medium to long term. Growth initiatives are still numerous but are likely to centre on priority areas such as infrastructure services (e.g., 5G networks, smart cities), technology innovation (semiconductors, artificial intelligence, quantum computing, biotech) as well as the large investment required for the energy transition. China will still provide growth opportunities but they are shifting from the drivers of the last 2 decades.
Global Economy: Both Hot and Cold but Fairly Benign Overall
The weak China versus strong US narrative is currently causing cross currents in global markets. We continue to watch both economies with great interest (as well as keeping an eye on Europe). Our base case is for both the strong US and weak China growth trends to normalise in coming months. As a result, the overarching regime of below trend but positive growth, alongside falling inflation, should hold sway, as it has so far this year.
Written by
David Cassidy, Head of Investment Strategy
David is one of Australia’s leading investment strategists.
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