It was a red October. Global markets were down sharply: the Nasdaq by over 9% in October, the S&P 500 by about 7%, the Euro Stoxx 600 by 6%, and with falls across Asia as well (the Shanghai Composite was down almost 8%). Many equity markets are at (or below) early 2018 levels, even after the bounce over the past few days.
Equity markets in small advanced economies fared slightly better than many major equity indexes, down 6% in October. There were significant falls in Hong Kong and Singapore (10% and 7% respectively), although some small economy markets were more resilient (Switzerland was down just 0.7%).
There are multiple reasons for this sharp global sell-off: rising interest rates and a strengthening USD, the impact of trade tensions, slowing global economic momentum, weaker corporate earnings, and so on. But like the ‘Murder on the Orient Express’, it is not a single culprit. Contributions came from all of these sources, and more.
The Goldilocks global economy is in the rear-view mirror, and the bears have arrived. The key uncertainty is how grumpy these bears will be; the extent to which they will damage the global economic recovery – and asset prices. On that score, there is good news and bad news.
Starting with the good news, the global economy remains in decent health – even if growth momentum has slowed markedly from early 2018. The IMF recently marked down forecast global growth from 3.9% to 3.7% for 2018 and 2019, but this is still as good as it has been for several years. And the US is growing strongly on pro-cyclical fiscal stimulus (ill-judged policy, but with the short-term effect of boosting US growth).
World trade growth data just released for August showed smoothed growth in trade volumes nudging up slightly, stabilising after a period of softening (although in USD value terms, world trade growth continued to moderate). But despite the slowing in world trade growth through 2018, growth remains well above most of the post-crisis period. And in other good news, TPP was ratified by Australia during the week, enabling it to go into effect in December. So far, the trade tensions are largely bilateral in nature (between the US and China) rather than systemic.
The economic data from small advanced economies also continues to show a measure of resilience. Although there has been a distinct slowdown in economic momentum from peaks in early 2018, export growth, PMI readings, industrial production, and the like, remain above their post-2005 averages for the most part (although some of the data for October are on the weak side). And unemployment continues to fall across the group. Growth in economic activity is slowing across small economies, but not precipitously.
This view from small advanced economies – the canaries in the mine of the global economy – suggests that the global economy remains in reasonable health, at least for the moment. This may change as US fiscal stimulus reverses out, or if China stumbles, but this is not evident yet.
However, the bad news is that many of the factors that have been roiling markets – and that carry risk for the global economy – are not likely to be resolved soon.
Start with trade wars and US tensions with China. Despite the evidence of costs in the US and China from these tariffs, there is no easy off-ramp from further escalation. The US recorded a record-high merchandise trade deficit in September (USD 854 billion), and this is likely to weaken further on loose US fiscal policy. I don’t expect substantive progress from the proposed meeting between Presidents Trump and Xi at the G20 in Argentina this month, and think additional US tariffs are likely to be imposed by January.
Beyond trade, there is a structural change in US/China relations that will lead to greater tension (note the recent speech by Vice President Pence). This growing strategic competition will lead to a gradual decoupling of the US and Chinese economies, with further investment restrictions and the like. The combination of erratic US foreign policy, an assertive China, and a more multipolar system, creates greater potential for geopolitical shocks.
There is also the potential for an inflationary shock, with tight labour markets, the possibility of higher oil prices (despite recent falls), growing political pressure on central bank independence, and the inflationary effects of trade wars. Indeed, my sense is that the impact of trade wars will come as much through the supply side (higher prices, lower productivity) as through the demand side.
Tighter US monetary policy and a stronger USD are also likely to persist. This will exert a drag on the global economy; slowing world trade growth and creating pressure for USD borrowers.
And there are some specific risks: the extent of the growth slowdown in China and the ability of policy-makers to manage it (probably OK in the short term); Italy and the Eurozone (about which I remain concerned); and Brexit (I continue to think that a compromise will be found).
Overall, the market turbulence in October should not be over-interpreted as a signal of a marked shift in global economic fundamentals. But market pricing does seem to be better reflecting a more complex global environment, with a range of political and economic cross-winds. Economic and market volatility will be the new normal.
At the movies, ‘The Hunt for Red October’ ended happily because the protagonists were able to coordinate through a fog of uncertainty (‘Give me a ping, Vasili. One ping only, please’). In the real world, Red October may not resolve quite as easily.
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Dr David Skilling
Director, Landfall Strategy Group