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Jupiter: Markets are steady, but something doesn’t fit

Global economic data appears inconsistent

Equity markets beckoned the new year in a robustly positive frame of mind, determined to put the blues of a dismal ending to 2018 behind them, and that infectious spirit of optimism has persisted. The extent to which major global equity indices have recovered a substantial portion of their losses of last year suggests all must be rosy in the garden and companies’ prospects are undimmed.

Yet government bond prices too have been rallying (the result of which is yields have fallen, in some cases sharply; yields on government bonds tend to reflect or anticipate changes to central banks’ monetary policies) in the belief that a recession is around the corner.

Gold prices have also been buoyant, further suggesting investors are looking for protection against future difficulties. Something seems inconsistent. Can all three premises be correct?

The economic data is not good. Global growth is decelerating from around 3.2 per cent last year towards an estimated 2.8 per cent in 2019.

The US, still substantially the world’s biggest economy (roughly 25 per cent of global GDP), is slowing and while companies remain broadly optimistic about prospects, some consumer data has weakened in the past few weeks. Europe is plain worrisome: Italy is officially in recession, German industrial data is sufficiently poor that it risks flirting with recession, and France is returning to its seemingly natural state of economic sclerosis. While the peripheral European Union countries are in better shape, the three biggest economies at the core of the eurozone are in a state of virtual atrophy.

China too is a preoccupation: its economy is estimated to grow at 6.2 per cent in 2019, down from 6.6 per cent last year. When comparing China with Europe and Japan, both struggling to maintain positive momentum, and US growth of around 2.1 per cent, you may well ask why a Chinese growth rate of “only” 6.2 per cent presents a problem.

At 15 per cent of global GDP, China is the second-largest economy in the world; even if it achieves it, 6.2 per cent will be the country’s slowest growth rate recorded in over 20 years apart, from 2009.

Of the incremental growth in the global economy, China alone contributes one third (and 10 years ago, the comparator would have been a quarter – its growth rate matters even more now to global prospects than a decade ago).

The difficulty is compounded by suspicions that the Chinese authorities are reporting optimistic numbers. Is the economy really only decelerating from 6.6 per cent to 6.2 per cent when other economies with whom China trades are decelerating much faster? How can China be growing at twice the rate of its domestic electricity consumption? Is the response by the authorities to cut taxes and slash banks’ reserve requirement ratios (the proportion of regulatory capital banks must maintain to protect their balance sheets in the event of significant defaults by creditors) fully consistent with an economy which is still growing at over 6 per cent and in good health?

It saps confidence when economists and experienced China-watchers fundamentally disagree with the official data and start making their own assumptions about what they believe is the reality.

Is it the pessimists who are right and the equity optimists who are going to suffer burned fingers? Why are equity markets seemingly so sanguine? There are two principal reasons. First, supported by tweets from president Trump, optimism persists that the US policy of ratcheting up tariffs in the trade war with China will be ditched, at least to the point of no escalation from the existing rates, if not scrapping them altogether.

Were a significant potential threat to global trade flows to be removed in the event an accommodation is reached, the likelihood of a global recession recedes. Second, opinion is hardening that US monetary policy may be relaxed to give a boost to the economy; there is speculation the next move by the Federal Reserve will be to cut interest rates and even, possibly, reintroduce quantitative easing.

In the UK it’s difficult to avoid the subject of Brexit. As we write there are just days to go before B-Day, and the position remains as clear as mud. However, for global investors, while Brexit is relevant it should not be an obsession. That’s not to say we’re not interested in the outcome!

John Chatfeild-Roberts is head of strategy for the Jupiter Independent Funds Team

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