Equity investors look beyond gloomy economic data
For several months now, no one has been able to deny that the global economy is slowing down. The PMI indicators are showing a downward trend. Manufacturing is experiencing a dramatic fall in some key industries. And yet the stock markets have been rising fast since the start of 2019. So what is going on?
Manufacturing confidence is down
One of the most popular economic indicators is international manufacturing confidence. The JPMorgan PMI indicators as published by global information provider IHS Markit each month are a good predictive indicator for investors. What happens is that when manufacturing confidence goes up, the global economy tends to grow, and when manufacturing confidence goes down, the global economy tends to shrink. The magical 50-point mark is very important in this respect: a manufacturing PMI above 50 points marks an expansion in economic activity and one below 50 points indicates a contraction.
Graph 1 shows the evolution of manufacturing confidence in the Western world (USA, Europe and Japan, green line) and the emerging markets (including China, Brazil, Russia and India, orange line). So what do we see? A downward trend since the beginning of 2018, both for the West and for the emerging markets. This negative evolution clearly points in the direction of a slowdown in economic growth. So is there reason to panic? Not really.
You probably know that the global economy rises and falls in cycles and that manufacturing confidence rose considerably in 2016 and 2017. It is to be expected that a period of economic boom is followed by a period of economic downturn. We can also immediately see that manufacturing confidence in both regions is not in any danger of falling below the 50-point mark just yet.
A global recession does not seem likely any time soon.
Graph 1: Evolution of economic activity
Source: IHS Markit
Manufacturing is falling even more quickly
However, the rapid fall in manufacturing in a number of important key industries of the world economy is a little more worrying. Graph 2 shows industrial activity in the technology, mechanical engineering and automotive sectors. We see that activity in these industries has been falling very rapidly since the start of 2018. Falling activity is not necessarily a problem as such, as these are highly cyclical industries.
It is mainly the speed of the decline that deserves our attention. For example, we can see that activity in the automotive industry has already fallen below the 50-point mark. This is associated with certain risks. One of these risks is the impact on other businesses. If the automotive industry is not doing well, this nearly always affects the suppliers.
Graph 2: Evolution of activity in key sectors of the global economy
(3 month average)
Source: IHS Markit
And yet the stock markets are on the rise
Despite these disappointing indicators, we have seen a sharp rise in the stock markets since the start of the year. This seems contradictory to say the least. Surely a decline in growth would lead to lower profits for listed companies? So why are investors suddenly so interested? Why are the stock markets going up? Why are equity investors pressing the 'Buy' button?
To answer these questions, we mustn't lose sight of the fact that stock markets mainly look towards the future. Investors reason that slower growth will probably mean that the central banks – led by the US Fed – will not raise short-term interest rates any further in the coming months. Consequently, long-term interest rates are also falling. Fixed-income products are no longer a viable alternative and stocks are attracting new cash flows.
We think this is the only valid explanation for the current bull market.
Geert Van Herck
Chief Strategist KEYPRIVATE
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