Overcoming their fears
Investors may expect slower growth, but not a recession
INVESTORS have recovered some of their confidence. In the first six weeks of the year stockmarkets plummeted, but in mid-February the S&P 500 index began a rally which has regained most of the lost ground (see chart). Emerging markets are back where they were at the start of the year. Another sign that markets are less fearful is the declining yield on speculative, or junk, bonds, which dropped from 10.2% on average on February 11th to 8.5% a month later.
The two big worries in January and February were that the Chinese economy was slowing fast and that the Federal Reserve might therefore have miscalculated when it pushed up interest rates in December. Perhaps the global economy might be heading back into recession.
Those worries have not completely disappeared: forecasts for economic growth are still being revised down. The OECD, a think-tank, predicts that global growth will be 3% this year, below its previous estimate of 3.3%. But slower growth is not the same as a recession.
In China the official figures continue to show a slowdown but not a catastrophic one: industrial output in January and February (the months were combined because of the impact of China’s new-year holiday) was up 5.4% on the previous year while retail sales were up 10.2%. Both figures were lower than those recorded in December. But both fixed investment and property sales were higher than expected. A rebound in commodity prices, seen as a proxy for Chinese demand, may also be a sign that the economy is not collapsing. And the Chinese authorities have eased monetary policy (via a cut in the reserve ratio for banks) to boost growth.
In America employment numbers have shown no sign of a deteriorating economy, although February’s retail sales were disappointing. The latest estimate of first-quarter growth from the Atlanta Fed’s GDP Now model is for an annualised rise of 1.9% (around 0.4-0.5% for the quarter).
The European Central Bank (ECB) did its bit to boost growth on March 10th by cutting rates further into negative territory, expanding its bond-buying programme and offering banks an incentive to increase their lending. The package had a mixed initial reaction from the markets, after Mario Draghi, the ECB’s president, hinted that rates could not be cut any further. But most economists seemed to think that the ECB had done more than expected.
The problem, according to Stephen King, an economist at HSBC, is that “the combination of weak nominal GDP growth and low interest rates suggests that central bankers’ monetary powers are beginning to wane.” Normally, monetary easing would weaken a currency, but the euro rose after the ECB’s move. The yen has also jumped since the Bank of Japan eased policy in January. It may take more to impress the markets these days than it did in 2012, when Mario Draghi turned the tide of the euro crisis: we have moved from “whatever it takes” to “whatever”.
Another issue for markets is that growth in corporate profits has stalled. The first-quarter profits of S&P 500 companies are expected to be 6.2% lower than a year ago. Even if energy companies are excluded, they will be 0.7% lower. Global corporate profits fell by 2% last year, according to Société Générale, a French bank; in emerging markets they were down by 12%. In response, firms have been cutting investment spending: Standard & Poor’s, a rating agency, estimates that global capital expenditure fell by 10% in 2015 and will drop further this year and next. In real terms global capex may be no higher in 2017 than it was in 2006.
Then there is political risk. The setbacks for Angela Merkel’s Christian Democratic party in German regional elections and the likelihood that Donald Trump will be the Republican nominee for president indicate that voters are in an ornery mood. Politicians may well respond to their anger by taking a more populist tack, increasing taxes on business and raising trade barriers.
All this means there is a limit to how exuberant any equity rally can be. This year may end up resembling 2015, when, after many twists and turns, most markets finished flat or down. Yet it is hard to imagine investors turning their backs on shares altogether. The latest poll by Bank of America Merrill Lynch shows that fund managers retain a higher-than-normal weighting in equities. With cash yielding virtually nothing and many government bonds offering negative returns, investors do not have much choice. It will take signs that the global economy (or at least America’s) is actually in recession for investors to succumb to outright panic.