The world economy is in excellent condition
The world economy is in excellent condition. This can be deduced from the monthly PMI figures that measure the health of the industrial sector. The JPMorgan Global Manufacturing PMI has just been published – and this has reached its highest point in the last three years.
The monthly update concerning worldwide manufacturing confidence is very important for economic growth and the financial markets. When manufacturing confidence increases, this always results in more investment and economic growth. The graph below demonstrates this relationship well.
PMI versus industrial production
Source: IHS Markit
If we look at 2016, we can see a good recovery of the JPMorgan Global Manufacturing PMI. After years of decline, this indicator saw a strong boost in 2016 and is now at its highest point in the last three years. We can also expect an increase in industrial production in the following quarters that will be positive for worldwide economic growth. This is a very positive indicator at the start of the new year.
The JPMorgan Global Manufacturing PMI rose in December 2016 to 52.7 points from 52.1 in November 2016. A figure greater than 50 indicates increased industrial activity. It is only if this indicator drops below 50 points that we need to be concerned, as we can then talk of a decline in industrial activity.
If we look at regional distribution, we can see an increase in manufacturing confidence in both developed countries and the emerging economies (such as China and Brazil). We can therefore talk about there being synchronised economic expansion. You also have to remember that in the last few years, it was only the West that was contributing to economic growth; a number of major emerging economies such as China were dealing with a slowdown in growth and in Brazil's case, there was a deep recession. You can notice how the curve of the emerging countries (Emerging) was under the critical figure of 50 points in 2015 and the first half of 2016; this clearly demonstrates the poor state of these countries.
Manufacturing confidence in developed and emerging countries
Source: IHS Markit
A side effect of this economic recovery is a rise in raw material prices. This increase in prices, accentuated by the strength of the dollar, gave a boost to countries that have to import raw materials. The graph below shows the development of input prices for industrial companies. You can see a sharp rise in input prices and this, of course, makes the production process more expensive. It will come as no surprise that the industrial companies will pass these prices on to their customers. This will cause inflation to rise in the coming quarters. This development must be monitored closely, as it may cause the central banks to tighten their monetary policy. After many years of a very relaxed monetary policy, we expect central banks to be tightening their purse strings.
Movement of input prices for the industrial sector
Source: IHS Markit
Conclusion: After a number of difficult years, the global economy is clearly improving. Worldwide manufacturing confidence has increased in both developed countries and the emerging economies. The flip side of the coin is the pressure on prices and that inflation is certainly expected to rise.
The message for investors is clear: the spread in portfolios can be more focused on assets with greater risk, such as shares and raw materials. Portfolios can be underweight in bonds. In terms of bonds, inflation-linked bonds offer an interesting option for diversification.
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