14 Jan 2020
2020 Global Economic Growth May Depend on Comprehensive Trade Deals and Fiscal Stimulus as Central Bank Monetary Policy Has Become Less Effective in Boosting Growth
Unless global growth reaccelerates, international stocks may remain stuck within the volatile range of the past two years, given their high sensitivity to economic conditions. In 2020, growth may depend on comprehensive trade deals and fiscal stimulus to reverse the 2019 slowdown in manufacturing and business investment. If tariffs are not lifted before businesses cut jobs, it may undermine the consumer spending that is supporting the world’s economy.
A recession is not inevitable. The global slowdown which began in manufacturing, has recently shown signs of stabilization. The widely-watched global manufacturing purchasing managers’ index ended 15 months in a row of declines and posted four back-to-back months of improvement as 2019 matured. The declines began the month the U.S. and China both put the first round of trade tariffs on each other in 2018. Hopes that we are nearing an end to the trade war may be helping lift manufacturing sentiment.
Signs of improvement in manufacturing
If the manufacturing sector fails to recover, those countries with economies that are most dependent upon manufacturing may be the most vulnerable to a recession. These include some of the world’s largest economies. Likewise, if manufacturing were to rebound, these countries may be the most positively impacted.
Although the services sector of the global economy is larger, the manufacturing sector tends to be a good indicator of profit growth in the quarters ahead. Earnings per share growth for global companies in the MSCI World Index dipped below zero in the third quarter of 2019. This deteriorating profit outlook may have contributed to business leaders’ increasingly cautious outlook. Most CFOs surveyed in the latest Duke CFO Global Business Outlook poll see a recession starting sometime next year, with more than half of them seeing a recession by the U.S. election.
Weak CFO confidence
Debating the accuracy of their forecast is less important than actions CFOs are taking in response to this outlook. For example, the survey also shows that CFOs are pulling back on business investment plans for the coming 12 months. The growth rate of business spending on equipment has already turned negative in many economies. Fortunately, businesses have not yet cut back on labor. Employment is consistently strong across economies as different as Canada and China. Remarkably, strength in the labor market can be seen even where the global economy is weakest; employment is at an all-time high in the German manufacturing sector. This labor market resilience has supported the consumer spending that has kept the global economy from sliding into a broad recession.
Without a trade deal, the heightened tensions that have contributed to the slowdown in demand may not ease. If no deal can be reached between the U.S. and China in the coming months businesses may finally begin to cut back on labor, undermining the key support for the global economy. We continue to monitor trade developments closely, as jobs may depend on it.
Although hard to assess with any precision, the odds of a comprehensive trade deal that revives global growth in 2020 are not zero. After all, there were some major trade deals in 2019. Lost in the escalating trade tensions with China is the fact that the U.S. now has trade deals signed or pending with Japan, South Korea, Canada and Mexico, making up four of the U.S.’s top seven trading partners, accounting for a combined 60% of U.S. trade.
According to the US Census Bureau, U.S. trade with both Canada and Mexico was nearly as large as U.S.-China trade in 2018. This year could see those levels exceed U.S.-China trade, which has seen a sharp pullback. Looking ahead to 2020, a post-Brexit deal between the U.S. and the U.K. may be coming, along with a deal between the U.S. and Europe tied to autos.
However, the “Phase One” deal also doesn’t mean the Trump administration won’t continue to use tariffs and other trade barriers as a tool to coerce various concessions from, or to punish, other countries. This ongoing uncertainty is likely to keep a lid on corporate confidence—and in turn capital spending. Even with trade tensions somewhat reduced, corporate confidence will also likely remain muted in what is likely to be a very contentious election year
Monetary policymakers at the Federal Reserve, European Central Bank and Bank of Japan appear to be on hold heading into 2020, after each lowered interest rates in 2019. The leaders of these central banks have been insisting that fiscal policymakers enact stimulus though stepped-up government spending or tax cuts, both made easier by these low interest rates. Starting around this year’s annual gathering of central bankers and finance ministers in Jackson Hole, WY in August, the list of countries focusing on fiscal stimulus for 2020 is growing.
The economic and earnings outlook for 2020 may depend on how soon might a potential cutback on labor by businesses, as demand continues to fade and unsold inventories pile up, be rescued by a trade deal and/or fiscal stimulus.
Small to large cap?
Since the yield curve again inverted in 2019, it is possible the long-term trends in relative performance are again nearing a reversal, potentially signaling shifts to outperformance by value, large cap, and international stocks in 2020.
The track record of the inversion of the yield curve as a signal of a potential bear market and recession on the horizon may have some investors focused on preparing for a more difficult market environment. When markets get difficult, investors often instinctively seek to concentrate their portfolio on what had been leading and eliminate what had been lagging. That instinct might limit investors from seeing potential opportunity as the yield curve inverts and signals the potential for a reversal in the leaders and laggards.
Resisting the emotional response to difficult markets by maintaining exposure to the laggards through portfolio rebalancing may offer the opportunity to benefit from the potential for a reversal in relative performance trends. It is worth noting that compared to the past 20 years, global stock markets are becoming less synchronized with each other, suggesting a globally diversified portfolio may provide effective management of market volatility.
Investment involves risk. Past performance is no indication of future results, and values fluctuate. International investments are subject to additional risks such as currency fluctuations, political instability and the potential for illiquid markets. Investing in emerging markets can accentuate these risks.
The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.
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Diversification and rebalancing a portfolio cannot assure a profit or protect against a loss in any given market environment. Rebalancing may cause investors to incur transaction costs and, when rebalancing a non-retirement account, taxable events may be created that may affect your tax liability.
Forecasts contained herein are for illustrative purposes only, may be based upon proprietary research and are developed through analysis of historical public data.
Fixed income securities are subject to increased loss of principal during periods of rising interest rates. Investment value will fluctuate, and investments, when sold, may be worth more or less than original cost. Fixed-income investments are subject to various other risks including changes in credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications and other factors. High-yield bonds and lower-rated securities are subject to greater credit risk, default risk and liquidity risk.
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The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc, and the source of comments provided here.
About the author:
Liz Ann Sonder, Senior Vice President, Chief Investment Strategist, Charles Schwab & Co., Inc.
Jeffrey Kleintop, Senior Vice President and Chief Global Investment Strategist