In the UK, Brexit continues to take centre stage, with the final outcome still uncertain. The full effects of this deal - no deal uncertainty are now starting to show in recently published economic data.
Data released today shows that the UK economy grew by just 1.4% in 2018, the worst performance since 2012. Just last Thursday, the Bank of England officially downgraded its forecast of UK economic growth for 2019, from 1.7% to 1.2%. This would be the lowest growth since the recession in 2009. Even this downgraded forecast is based on the UK having a smooth transition out of the EU – i.e. achieving some sort of deal with Europe. The chances of a UK recession this year are an unnerving 25%, according to the BoE.
Brexit uncertainty has affected business confidence, in turn delaying decision making and reducing business investment. Investor sentiment in the UK has deteriorated, as shown by the sharp falls in financial markets over the past year and by the relative discounted valuations of UK assets.
Yet even without Brexit, it would be hard to imagine a scenario where the UK economy would be firing on all cylinders. Economic growth is slowing in virtually all developed markets. In 2018, the combined economic growth of the entire Eurozone block was an uninspiring 1.2%. Most notably in 2018, Italy entered a technical recession and the German economy contracted from the second to third quarter of the year.
Even in the faster growing and less developed markets, economic growth is slowing. In India, growth slowed from 8.2% in 2017, to 7.1% in 2018. The Chinese economy – responsible for fuelling the majority of global growth in recent times – seems to be running out of gas, with growth of 6.4% being the lowest in a decade.
In fact, the only major economy that seems to be performing well is the US – buoyed by Trump tax cuts and strong consumer spending. Growth of 3% in 2018 is the highest rate in 10 years, with unemployment also very close to a 50-year low.
However, even in the US, there are dark clouds forming. The IMF has recently lowered global economic growth forecasts for 2019, from 3.7% to 3.5%, citing a growing number of threats to global growth, namely: trade tensions and tariff escalations; quantitive tightening; Brexit uncertainty; and an accelerated slowdown of the Chinese economy.
But whilst Brexit may be hogging the front pages in the UK, it is surely the most globally insignificant of the threats cited by the IMF. Brexit may be partly responsible for the deteriorating outlook in Europe, but it probably isn’t worrying the Chinese and Americans too much.
In China, growth has slowed due to a combination of rising debt and trade tensions with the worlds’ largest economy. In the US, the deteriorating outlook is mostly due to tightening monetary conditions, but also because this years’ tax cuts were essentially a one-off gain, that won’t be repeated.
American concerns are most evident in the bond markets. Here the yield curve (the difference in yield between short and long-term US treasury bonds) has flattened to the lowest level since the financial crisis. This implies that the market believes economic growth is set to slow and is unsustainable at current levels. The yield curve has not yet inverted but is close to doing so, which would be a major indicator of an upcoming recession. As well as merely signalling market sentiment, the yield curve can also directly influence bank lending. An inverted yield curve would make lending less attractive, as borrowing at short term rates and lending at long term rates – which is what banks do – would be unprofitable.
Financial markets are leading indicators of economic distress. They aggregate the opinions of the market participants and produce a consensus, in this case, discounting asset prices. Since markets are mostly moved by the largest and most well-informed participants, we can assume that the markets - as a whole - have a better understanding of the future, than the average participant. The global stock market falls seen in the second half of last year indicate that investors believe that corporate earnings and thus economic growth will be lower in the future. However, the markets are also hugely prone to over-reactions.
It’s not clear if recessions in the major developed economies are imminent. But what we do know is that economies don’t carry on expanding forever. Occasional recessions are a certainty, and now overdue, if economic history is anything to go by. It is becoming increasingly clear that globally – at least in developed western markets - we are in the late stage of a long economic expansion, that has generally been sustained since the financial crisis.
The main contributor to slowing growth in developed economies is a lack of productivity growth. In advanced economies productivity growth is lower now than it was in the years before the global financial crisis. The current economic expansion has been job rich but productivity poor. The majority of new hires have gone into low productivity areas of the economy i.e. restaurants and leisure. Past increases in productivity growth were based upon technological revolutions: the IT revolutions in the 90’s and the financial revolution in the 2000’s. Any future improvements in productivity will be centred around what has been termed, the 4th Industrial Revolution: Digitisation. Digitisation covers a host ground breaking technologies such as artificial intelligence, autonomous driving, drones, gene sequencing, urban mobility etc. These are technologies that could add value to the economy, either by making new things (that are valued) possible or by reducing the time it takes to complete current activities. In many cases, the technology already exists, but wider take up has been poor, due to barriers to implementation, such as high upfront costs and a lack of communication of the perceived benefits.
So, whilst geopolitical events, like Brexit and Chinese-American trade wars, may be making the headlines and negatively effecting global growth in the short term, in the long term what the global economy really needs is to solve the current productivity problem.
GCIS - Commercial Intelligence - Market Intelligence
This does not constitute investment advice. Past performance is not a guide to future performance. The value of investments can fall as well as rise.