Sailing into the wind
It has been evident for much of the past several months that the global economy is slowing. There are many contributing factors: weaker performance in Europe and China, growing trade tensions, and the impact of a strong US dollar.
These headwinds are unlikely to disappear anytime soon. Indeed, during the week, a 10% US tariff was applied to a further US$200b of imports from China with more likely to follow. I don’t see a ready resolution, and expect that US/China economic relations will continue to deteriorate (and for the bilateral trade deficit to continue to expand on the back of US macro policy). And the likely ongoing strength in the US dollar will continue to constrain world trade growth (if anything, monetary hawks are currently more important than trade hawks).
But looking across the small advanced economies – the canaries in the mine of the global economy – suggests that, for the moment, this is more of a moderation in economic momentum than a marked slowdown. The global economic recovery continues, even if it is not as synchronised or strong as at the start of the year.
Small economies no longer have strong following winds, but they are making good speed sailing into the wind. Small advanced economies continue to out-perform larger economies despite their acute exposure to a more complex international environment. GDP growth across the small advanced economies group was 2.8% in the year to Q2, a pace they have maintained since Q3 2016, and well ahead of GDP growth in the G7 (2.2%) and the EU (2.1%).
8 of the 13 small advanced economies are growing at 2.8% or above: from Ireland and Singapore to Switzerland and the Netherlands. Multiple small economies have been at or above 3% growth for several quarters now. Small economies are responding effectively to emerging challenges (compared to the UK, for example, which grew at just 1.3% on the back of Brexit-related costs and uncertainties).
Similarly, my tracking portfolio of internationally-exposed stocks from small advanced economies continues to perform strongly. This ‘small economy globalisation portfolio’, which is constructed to be exposed to the strength of globalisation, is up over 7% year to date, in line with aggregate world equity benchmarks. Although the impact of international trade tensions is clear in the return profile, these small economy global firms are weathering the international cross-winds well so far.
However, recent small economy data also confirm a softening in the global economy. On an annualised basis, GDP growth in Q2 slowed to a bit over 2%. Monthly merchandise trade data also show an ongoing growth slowdown since the start of 2018, in line with dynamics in world trade growth, although small economy export growth is still at healthy levels (over 8% in USD value terms in July). This slowing should also be kept in context; although economic momentum is off the peaks of 2016 and 2017, it is well ahead of much of the post-crisis period.
The global outlook indicator that I calculate based on forward-looking data from 13 small advanced economies has been gradually slowing from its highs in January. But it is still above trend, at levels seen in mid-2017 - and well above almost all of the post-crisis period. Business and consumer confidence, export growth, industrial production, and PMI readings across small economies are generally solid – and compare well to larger economies.
There is some geographic variation. The two small economies with the weakest quarterly GDP growth readings in Q2 were Singapore and Hong Kong – the economies with acute exposures to US/China trade tensions. And Hong Kong’s Hang Seng Index briefly entered bear market territory last week. The escalating US/China tariffs are clearly having an impact, but it is not yet systemic.
This generally resilient performance by small economies that are deeply exposed to the global economy suggests that the global recovery remains in decent shape. Of course, there are any number of risks: US/China tensions (economic and political), ongoing Eurozone challenges (such as Italy), and pressures from a strong USD on emerging markets, to name just a few.
And although the real economy looks in reasonable shape, a decade on from Lehman we should not be complacent about financial risks: from record-high levels of debt as a share of GDP around the world, to stretched US equity markets, and market distortions from the hunt for yield. As interest rates move up, stress is likely to emerge.
There seems to be an emerging consensus that a recession in 2020 is likely, but probably not before (see Nouriel Roubini’s recent essay). The outlook from a small advanced economy perspective is broadly consistent with this: despite gathering clouds of slowing growth and growing political risks, the storm seems a little way off making landfall. But of course, history shows that strong consensus is as often wrong as it is right.
That small economies are travelling reasonably well is an encouraging signal on the health of the global economy. But small economies also understand from experience that storms can appear quickly. My concern at the talk of the Goldilocks global recovery last year was that Goldilocks was accompanied in the story by three bears. So far so quiet on the bears front, at least from a small economy perspective. But an economic, financial or political shock may have an out-sized effect on the global economy if it interacts with already slowing global growth. Small advanced economies are a good place to watch for changing global weather.
Dr David Skilling
Director, Landfall Strategy Group