All about growth

The tumultuous start to 2016 has raised fears about US growth prospects – to the point where we need to address recession talk. Given the increasingly loose monetary outlook, a US recession and/or global downturn seem an unlikely scenario without a significant, systemic trigger. More of the same slightly sluggish growth is the most likely scenario and with that comes the continuing challenge to corporate earnings – and beyond.

May the odds be ever in your favour…

All this US recession talk is hard to ignore. US growth always matters, but this year it was supposed to be inspiring global recovery, or at least taking the edge off the unsettling impact of accompanying higher US interest rates and China’s patchy rebalancing. The prospect of a US economy in decline is a worrying one.

But, how serious is this risk? US GDP grew by an annualised 0.7% YoY in Q4 15, with the economy barely shifting the final quarter. A survey of 51 economists by the Financial Times – held just after the last Fed vote – put the chance at 20% in the next 12 months. But, technically, there’s a risk of US recession every year and we’re always getting closer, unless we’re in one. When asked, in a milder economic climate in December, the same survey came back with odds of 15%. You have to ask if a ‘leap’ of 5% is worthy of the amount of column inches and market angst.

Just to put these recession odds in context, you can currently get 5/1 odds on a brawl on the field at this Sunday’s Super Bowl, Tottenham Hotspur winning the English Premier League or France winning the Six Nations. None of these are impossible and neither is a US recession. Intuitively we can see there are more risk factors in 2016. But it is hard to imagine a recession in a world where there is so much support for households and companies. Moreover the environment is also very different to 2008: banks’ balance sheet are stronger, refinancing has been pushed out etc.

Volatility doesn’t always mean crash. Asset prices are falling, but statistics on employment, output, confidence and incomes aren’t signalling the end of the cycle. In this context, it will probably take a hefty trigger – a systemic failure or significant policy misstep – to turn the undoubted stress in the system into a US recession.  What is more likely is more sluggish, slightly disappointing growth. Not universally, India is the stand out example of the oil-price beneficiary in emerging markets. The Eurozone should begin to reap the rewards of recovery – although this represents the archetypal problem with 2016, one of our primary economic hopes has the potential to go very wrong. Yesterday, the European Commission only marginally downgraded its growth forecast for this year to 1.7% from the 1.8% predicted in November, but it also noted that “The chances of things turning out worse than forecast are now greater than the chances that they might turn out better.” There are several unpredictable political factors in the European mix that could turn nations inwards and disrupt movement of goods and people. Arguably it’s here we should be focusing concern, not the US….unless political concerns increase here too.

Inevitably, all this speculation about US growth puts the spotlight on the Fed’s December rate increase. As the FT put it this week, there are currently four broad schools of thought on the move: it was just plain wrong; it was wrong in hindsight; it was too well trailed –  which meant the rate rise tightened already tighter markets; or the Fed was right to move, but wrong to think that it would be moving again in 2016. The latter view, as the FT points out, is pretty much the same as the ‘plain wrong’ argument, since the point of starting to increase interest rates is that you’ll carry on – within a year at least!  But, looking at the odds, that now seems increasingly unlikely. At the start of the year Fed funds futures indicated just a 5% chance Fed would hold for all of 2016, a week ago it was 30% and now 60%. The decision on UK interest rates this week was 9-0, as the lone hawk ceded to the dovish majority. A rate rise in the UK now looks unlikely in 2016, testament in itself to growth issues . In it’s latest Inflation Report, the Bank of England cut its forecast for growth this year to 2.2% – from 2.5% predicted in November. Nevertheless, this still leaves the UK as one of the fastest growing developed economies this year, along with the US. That’s the ‘zero’ world we live in.

Trouble at mill…& oilfield & shop…..

The one US recession we can point to is in company earnings. With 40% of S&P 500 reports in, blended earnings (actual & forecast) have fallen by -5.8% for Q4 15. Unless this figure moves into the black, it will mark the first time the index has seen three consecutive quarters of year-on-year declines in earnings since Q1 09 – Q3 09, according to Factset. In Europe, the direction is more positive, albeit partly because recovery started later and comparables are easier. We’re just starting the European season and earnings are coming in around 4% below expectations, which stand at  a rise of 1.5% (excluding financials).  

Both regions – especially the US – are of course being hurt by the impact of falling oil prices across the supply chain. But, as we noted in our recent UK Quarterly Profit Warning Report, sectors you’d expect to benefit from low oil prices are still seeing a large number of companies downgrading their estimates. A third of General Retailers still issued profit warnings – the highest since 2011, when disposable incomes came under pressure from rising prices and muted wage growth. This new peak reflects rising competitive and disruptive pressures, which echo across a number of sectors. There’s also overcapacity – global overcapacity – pushing down on prices. And, of course there are the on-going problems of trying to plan and invest in a VUCA world (volatility, uncertainty, complexity and ambiguity).

This growing earnings challenge has wider implications for wages and for taxation, where longstanding global conventions are being tested by globalisation and the pressure to bolster fiscal accounts battered by bailouts and slow growth. A survey from Capita shows that UK dividend cover has fallen to its lowest level in six years and it predicts the first significant decline in dividends since 2010, putting more pressure on boards. It’s in times of earnings stress that we find more accounting issues.

So markets aren’t entirely crying wolf? Yes and No. There are obvious stresses in the system, but whether they’re enough to justify this ramp up in market turmoil is moot point. Only time will really tell. But, we’d postulate that perhaps the more sanguine reaction of most company executives we speak to – versus the jumpier markets – is a measure of how out of kilter asset prices have become in this world of zeros than the fundamental state of the global economy. That there’s no doubt it’s not an easy time – and companies’ focus on self-help, including M&A, underline this – but it’s not the worst of times.

 

 


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