Asynchronous slowdown – it doesn’t roll off the tongue as nicely as “synchronized global growth,” but it seems to be a fitting description of the oncoming macro environment. In recent months, we’ve covered the likely factors that can act as a drag on global growth. The linchpin is policy tightening from the Fed and other central banks that could bite into economic activity (as we already see evidence of in the US housing market). The list also includes growing trade tensions and supply chain interruption (see falling global auto sales), sluggish capital investment, a Brexit supply shock, and fiscal policy limitations that come with rising deficits.
On a brighter note, these headwinds should be less synchronized as regional economies are at different points in the cycle. The US has the most to lose as recent growth in the 3.5%–4.0% GDP range was supercharged by the $1.5 billion tax cut (Source: Committee for a Responsible Federal Budget). We expect US growth to decelerate next year, but to a still-respectable 2.0%–2.5%. In contrast, euro area growth already downshifted in Q1–Q3, establishing a lower bar for expectations – Brexit uncertainties notwithstanding. China presents the greatest macro wildcard as a credit and manufacturing slowdown is offset by a government with plenty of fiscal and monetary latitude.
Gauging Global Macro
In summary, we think the global economic backdrop for 2019 will be one of uneven deceleration driven by the US, which will mean-revert to something closer to longer-run potential GDP. We do not yet see a US or global recession for next year as consumption is supported by strong employment trends in many countries, but the possibility cannot be ruled out. Policy mistakes (from President Trump, China’s President Xi, Fed Chairman Jerome Powell, or British Prime Minister Theresa May) at this late stage of the cycle could exacerbate the slowdown to something more painful. We estimate the probability of a US or global recession next year at 30%. This is higher than most current estimates we see, but still represents less than a 1 in 3 chance.
We are always somewhat reticent about making forecasts, but acknowledge it comes with the territory. This year, however, the market environment makes it even more difficult. Three of our favorite touchstones – the trajectory of growth, market sentiment, and valuation – offer conflicting signals. On growth, the message is mixed because GDP in most regions is likely to decelerate but remain positive. So the direction (positive) supports risk assets but the rate of change (slowing) does not.
This leads to problem number two: What’s priced in? Arguably, falling stock prices and widening credit spreads1 in October and November have already begun to reflect many of our concerns for next year. The October/November correction stole much of our pessimistic thunder for 2019.
Finally, valuation is providing few clues because prices are no longer at extreme levels. Rising interest rates and slowing growth have put sovereign / high quality bonds closer to our estimates of fair value. Likewise, solid earnings growth, falling price-to-earnings ratios (P/Es),2 and widening credit spreads have taken stocks and corporate bonds from very expensive back to average or slightly above. Investors, already skittish, are unlikely to find much comfort or direction in these mixed signals.