It doesn’t seem like five minutes ago that we were talking about a synchronised global recovery. Today my inbox is full of articles asking if this is ‘As good as it gets’.
Have things really turned south that quickly and what is driving this change of heart? This week we’ll take the temperature of the global economy, M&A and capital markets to try and work out if we’re really losing momentum.
You wait almost a decade for a recovery and then suddenly everyone seems to be predicting its demise. The ‘time since the last recession’ issue is part of the problem. The average US economic cycle since WW2 is five years. This one is about to celebrate its ninth birthday. In economic terms it’s old and should be slowing down – so everyone looks for signs that it is.
But is there more to this than a self-fulfilling prophesy?
The end of an era
Our 18th Global Capital Confidence Barometer (CCB18) doesn’t show business leaders talking themselves into a slowdown. Far from it. Economic confidence is still high. That said, confidence in global credit markets is levelling out and dipping in the case of equity markets. As we said a few months back – this is shaping up to be a different type of year. The end of the Goldilocks era of low inflation, low interest rates, and low growth is going to hurt if that is all you’ve known for a decade. Interesting to note that in CCB18 it’s ‘rising inflation’ that’s picked as the number one hindrance to their investment plans by 49% of global respondents – well ahead of ‘market volatility’ at 35%.
Although, inflation and market volatility have, of course, become closely linked. After barely moving for years, even small movements in US inflation could have a profound impact on activity and confidence. Just look at the column inches devoted to whether the yield on benchmark US 10Y bonds would breach 3%. Of course, it’s an arbitrary point. But, it’s the first time since 2014 that yields have been this high and it’s a reminder that we’re going to have to get used to a higher (if not high) interest rate world, with consequences for earnings and capital.
There are still forces pushing equities higher – e.g. US tax reform and earnings expectations – but inflation concerns and how these might relate to the Fed’s next steps seem to be keeping a lid on prices for now.
Who turned down the growth?
If we look at what’s happening to global growth, this is also slowing – but only in patches. The latest Fulcrum Nowcast shows global activity dropping to about 4.2% in early April, down from the peak of 4.5-5% in late 2017. The data shows manufacturing growth stalling and consumer spending dipping – possibly due to the rise in oil prices. But if we look geographically, this fall in activity is really centred on Japan and the Eurozone – with the UK stuck in the slow lane for a while now.
The drop in Eurozone growth from 3.5% in late 2017 to 1.2% in early April is especially worrying given it’s position as the poster child of the 2017 global upturn. Activity in early 2018 was certainly hit by snow and flu – so we should see some Q2 rebound. But, the breadth and depth of this fall suggests something more fundamental is afoot, with companies starting to change behaviour ahead of a normalisation of ECB policy. Interesting to note that Mario Draghi, whilst being relative bullish on growth, today reiterated that the ECB could keep buying bonds after September.
But, if we look more broadly, global activity remains relatively solid and above trend. If we put this alongside historically low interest rates, high levels of liquidity and a refinancing wall pushed back into the 2020s, we also get exceptionally low forecast default rates of around 1% in 2018 . In fact, 2017 was a record year for debt issuance, with the second half in particular driven by increased appetite for M&A.
Again CCB18 shows global companies confidently pushing forward with deal making. A good part of that is being driven by the need to remake their business in the face of technological and behavioural change. But companies still need the confidence to borrow and spent – and that’s still there.
Why so worried?
So why is there a palpably increased sense of worry? To use the old adage: ‘Recoveries don’t die of old age’. True. But mature recoveries like this one tend to have a gathered a few skeletons. Investors have built considerable market consensus around the long-running sweet spot of low-risk, rising growth and ultra-low interest rates. Trades are potentially very crowded, which will make markets highly sensitive to adverse data. As we’ve mentioned many times, ample liquidity has also encouraged competition in the debt market – to good and worrying effect. Documentation has weakened, there is less flexibility for underperformance and credit quality of new issuers has deteriorated. Interest cover is better than 2006-7 – but that could change if economies weaken and interest rates rise.
There is also sense that monetary, fiscal, trade or foreign policy missteps could at best stymie the recovery and at worst undermine it completely. Trade war concerns, talk of tighter technology company regulation, and rising tensions between East and West do not provide the best backdrop to growth. But, even without missteps there is a risk, as the World Bank recently noted, that this could be as good as it gets for the global economy without further investment from governments to boost productivity.
In CCB18, of the 75% global respondents expecting further infrastructure spending in the next 12 months, 64% said it would have a positive impact on growth, a further 14% said it was critical, and most companies want that spending to come in technology and transport.
So, in answer to our original question, there is a sense that we’ve seen the peak in some areas. Clearly there is greater stress in some sectors – very notably retail, where defaults have hit a record high. But it’s too soon to call the overall peak of this global cycle – in economic, market or deal terms. What we can say is that risks are building; the risk of policy misstep is higher now than at any point in this recovery and all good things do eventually come to an end. When the cycle does turn, it will be important that central banks and governments have some firepower – which is why it’s so important that this recovery is supported now.
You can read more about our 18th Capital Confidence Barometer <here> . Next week we’ll be focusing on the UK results and cross-border deal making in 2018.