PMIs: LACKLUSTRE GROWTH ON THE CARDS
Our global GDP-weighted manufacturing PMI slipped to levels matching the average of the previous 12 months, mainly because growth slowed in developed economies. While growth was generally stable in emerging markets, the improvement in business sentiment stalled.
The global services PMI also fell slightly, but is still pointing to modest growth. This left the global composite PMI essentially unchanged at below the average of the past 12 months in developed economies and above that average in emerging markets. Encouragingly, after lingering below 50 between May 2015 and June 2016, the emerging market composite PMI has now been positive for two months. However, we have not had much confirmation from the hard data. Industrial production growth has improved in emerging markets, but this is due more to a bottoming-out in Brazil and Russia than to genuine acceleration. Trade has remained weak.
Where were the surprises? Not so much in the eurozone. The manufacturing PMI fell further into negative territory in France and suddenly dropped into contraction territory in Italy. But the improvement on the services side in both countries was reassuring. The main surprise came from the UK, where PMIs recouped their post-Brexit losses. Although it now seems that the negative impact of the Brexit vote was initially overstated, we think it is still too early to tell.
In emerging economies, the halt in the improvement in Brazilian manufacturing was disappointing, as were the declines in China and South Korea. A weak number in Turkey had been more or less expected given the turmoil in the region. India stood out positively with an especially strong gain in the services sector. Japan disappointed with only a marginal improvement in the manufacturing PMI and a dip in services. This contrasts with the tight labour market and the improvements in workers’ earnings, giving the economy a two-sided face.
US DATA SEAL THE FATE OF SEPTEMBER HIKE
Shockingly, the ISM manufacturing index dropped sharply and suddenly. This could easily be dismissed as a one-off. But the decline among the components in the ISM manufacturing index was broad-based. New orders minus inventories, which leads the overall index with a decent correlation, fell to a level which implies further weakness. Further job losses in the sector underscore the prolonged flat-lining of employment in US manufacturing.
August’s labour market report was disappointing, although not outright weak. Employment growth slowed and the number of unemployed people rose, although this was not enough to be reflected in the unemployment rate, which held steady at 4.9%. Wage growth slowed as well as the average workweek, setting consumption growth up for a deceleration.
The main implication of this data is that in our view, an increase in the policy rate this month is off the table. The market-implied probability of a hike has now fallen by 10 percentage points to 33%. With inflation and inflation expectations this low, we think the recent data confirm the view that the Fed can wait until December with the next rate increase.
ASSET ALLOCATION: POSITIONED FOR A DIFFERENT INVESTMENT CLIMATE
If markets can shrug off disappointing economic data because they would imply lower-for-longer interest rates, one can question the odds of a market correction in the next few months. We are still positioned for a change in the investment climate since we regard several asset classes as expensive. Thus, we are underweight in global equities, emerging market debt in hard currency and commodities.
WHAT COULD CAUSE A CORRECTION IN COMING MONTHS?
Valuations could be a trigger, but given the still low interest rates and low bond yields, many assets can remain overvalued for a while. With the market ‘priced for perfection’, disappointing economic or earnings data could be a catalyst. US corporate profits have now fallen for several quarters and the risk is that companies start cutting wage bills. Quarterly profit declines often foreshadow slower economic growth. Indeed, eurozone leading indicators have weakened.
In Japan, central bank governor Kuroda has said that this month’s monetary policy review will not mean less policy accommodation. More can be done when it comes to the quality and the quantity of the Bank of Japan’s asset purchases or cutting interest rates further into negative territory. The risk is that the BoJ underwhelms, fanning the debate about the ability of central banks to hit (inflation, growth or employment) targets in the current circumstances.
Finally, there are political uncertainties, including the outcome of the US presidential elections, the constitutional referendum in Italy, the struggle to form a new administration in Spain and elections in Germany where euro-sceptics are gaining ground (although this is probably less of a worry for Germany than for other EU member states).