With the coronavirus impacting markets and threatening to derail the world economy, BMO Global Asset Management assess the global economic outlook and the impact of longer-term trends.
Steven Bell, BMO Global Asset Management’s Chief Economist, says: “We were positive on the world economy and risk assets in general before the sudden outbreak of coronavirus. It remains a huge source of uncertainty and the economic impact on China and the rest of the world is probably being seriously underestimated.
“The stringent controls imposed by the Chinese authorities seem to be working and the growth of new cases slowing. If this continues, we expect the output in China and the rest of the world to bounce back.
“If we are correct in this view, we can return to assessing the fundamentals – and they look positive.”
Alongside the coronavirus outbreak, BMO Global Asset Management sets out the following trends shaping the global economic outlook.
Improvement in manufacturing could be key for earnings and equities: The manufacturing sector has been in a recession but there are now signs of a turn. The Purchasing Managers’ Index has picked up a little and new orders relative to inventory suggest this recovery will gather pace. This is good news for financial markets. Manufacturing may be tiny relative to services as a share of GDP in developed markets but when it comes to corporate earnings and equities, manufacturing is key. The turnaround is being led by semiconductors, as the 5G roll-out starts in earnest. Cars also drove the manufacturing recession, but we’re starting to see signs of stabilisation.
A ceasefire in the US-China trade war: The structure of the Chinese economy is significantly changing, with the service sector booming. While Chinese exports to the US have fallen as a result of the trade war, other Asian countries and Mexico have filled much of the gap. The markets welcomed the ‘Phase 1’ trade deal and for now, it seems in the interests of both sides to maintain the peace. Trade tensions have not gone away. We expect them to revive as the presidential election heats up.
US Presidential race: when will it become a market issue? Markets seem to believe that a Democratic victory in this year’s election would be bearish but assume Trump will win. Opinion polls and betting markets foresee a closer race. This inconsistency may be resolved after ‘Super Tuesday’ next month.
S&P earnings set to recover nicely this year: Equities are all about earnings, and earnings are all about the economy. Once the impact of the coronavirus is behind us, we expect the manufacturing recovery and decent economic growth in the US to help S&P earnings recover nicely during the course of this year.
Brexit negotiations get going but they could turn acrimonious: There is no practical reason why a basic free trade agreement cannot be negotiated this year. Negotiations on services will be subject to much greater protectionist measures, largely due to the UK’s large trade surplus in services with the EU. Whatever deal the UK strikes, UK firms will be in a weaker position competing in Europe. Brexit is a major challenge for the UK economy. However, the UK remains resilient, with an educated nation, flexible labour market and outstanding institutions. The Boris Johnson government is stressing divergence, the EU wants control over UK regulations. Conflict is likely before compromise.
Some UK fundamentals are worrying but falling mortgage rates brighten the overall picture: Brexit has distracted attention from UK fundamentals. There has been a powerful bounce in economic surveys following the general election but there are negatives. Wage inflation is rising but productivity is growing by less than 1%. 4% wage growth means costs rising 3% per year. This is not consistent with 2% inflation and so something needs to give. We’ll be watching sterling closely, as this could be impacted. It’s not all bad news for the UK though. A major boost to infrastructure spending is set to be announced next month. In addition, UK mortgage rates have fallen, the housing market is stabilising as a result and prices could accelerate this spring.