Economic growth is hitting a speed ramp, but should shift into a higher gear, says strategist Peter van der Welle.
Markets are facing a mid-cycle slowdown rather than a late-cycle malaise which would cause a recession in the US or other western markets, he says. That means risks should reduce for stocks, but Robeco Investment Solutions’ multi-asset funds remain underweight on equities until the manufacturing outlook becomes rosier, he says in the team’s monthly outlook.
“The global economy is stuck in a persistent slowdown concentrated in the manufacturing sector amidst pervasive economic policy uncertainty,” Van der Welle says. “The latest ISM producer confidence index slid into contraction territory at 49.1 in August, delivering little comfort for investors.”
“Is this a harbinger of late cycle-malaise? Our view is that we are in a mid-cycle slowdown, but the economy is likely to shift into a higher gear towards the end of 2019. The speed ramp posed by the global mid-cycle slowdown in (car) manufacturing likely won’t bring global growth to a standstill.”
A mid-cycle slowdown is usually defined as a reduction in the levels of stocks kept by companies as expected demand for their goods falls, slowing the inventory cycle. “Today we observe something akin to a mid-cycle slowdown, as industrial production has slumped, and the US inventory-to-sales ratio is at 1.45, a level similar to the mid-cycle peaks observed in 1995 (1.44) and 2016 (1.47),” says Van der Welle.
“This similarity looks rather promising, though the difficulty is that a slowdown in the inventory cycle has historically also coincided with slowdowns that ultimately killed the expansion (such as in 2001). The presence of an inventory cycle slowdown is therefore a necessary but insufficient condition for establishing whether we are experiencing a mid-cycle slowdown or late-cycle malaise.”
In fact, some indicators are suggesting that worse is yet to come, led by inversion of the yield curve for US government bonds, the typical harbinger of a recession. What varies though is the length of time after the warning flag and the recession actually starting, Van der Welle says.
“The consensus view that has emerged is that the current US yield curve inversion heralds a recession in about 18 months, indicating we are late-cycle indeed,” he says. “However, IMF research shows that economists correctly calling a recession well in advance is effectively a statistical outlier, as they have only been correct five times out of 153.”
“The last two business cycles prior to the one we are enjoying now has shown that the lags between inversion and recession seem to have lengthened much beyond 18 months, occurring 29 months after the 2005 inversion and 33 months after the 1998 inversion.”
“There is corroborating evidence as well from an increased lag between a cyclical peak in the US ISM manufacturing index and the subsequent recessions. This lag has stretched way beyond the historical average lag of 36 months in the previous three business cycles, taking 80, 78 and 44 months respectively.”
“The lengthening of lead/lag relationships between yield curves, producer confidence indicators and recessions in recent decades suggests that this expansion, already playing in extra time, may have some vigor left.”
Van der Welle says the most likely explanation for a longer lag in recent decades is the declining importance of manufacturing for the global business cycle, in contrast with the increasing importance of the services sector, which now accounts for 45% of US GDP.
“While manufacturing is already in contraction, the services sector has remained resilient; the ISM non-manufacturing index is still indicating ongoing expansion in the US services sector. It is hard to envisage a US recession without the services sector showing signs it is about to slide towards outright contraction.”
Another issue is that current real policy rates strongly deviate from levels seen at the end of previous Fed tightening cycles, he says. Real policy rates in the US are below 1%, or negative (-1% for the Eurozone), with US real interest rates at the end of Fed tightening cycles significantly above 2% historically.
“Unless one believes that the real neutral rate of interest (i.e. the rate of interest that neither slows or accelerates the economy) is even lower than current real policy rates for these advanced economies, the net effect of actual low real policy rates should be a lengthening of the economic expansion, not a shortening of it,” says Van der Welle.
“The US has never seen a recession without real interest rates overshooting its long-run trend by at least 2% (today’s number is 0.96%). In short, real interest rates resulting from the Fed tightening cycle that started in December 2015 are unlikely to have been punitive enough yet to bring the US economy to a standstill.”
Meanwhile, fixed investment has been shown to drive business cycles. Looking at the bigger picture, the private fixed investment figures from the US show that the US investments impulse is still positive, in contrast to the negative impulse typically observed before a recession.
“So, if this slowdown indeed proves to be of the mid-cycle variant as we have suggested, the risks are lower for equities,” Van der Welle concludes. “Nevertheless, we remain cautious, as this mid-cycle slowdown still has momentum. For now, we remain underweight equities, awaiting opportunities to re-enter a global equity overweight position in the remainder of the year.”
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商号等： ロベコ・ジャパン株式会社 金融商品取引業者 関東財務局長（金商）第２７８０号
加入協会： 一般社団法人 日本投資顧問業協会