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Stabilisation in early 2019 considerably less likely

The FLI Cycle Tracker remained in the ‘bottom-left’ quadrant (growth below-trend and decelerating) for the ninth consecutive month. Although in the past two months the FLI was suggesting a move towards stabilisation, negative data developments have caused renewed deceleration. This makes the ‘Cycle Tracker’ look decidedly less healthy.

As such, the probability for stabilisation in global activity in early 2019 appears considerably less likely. Compounding this negativity, the FLI’s quantitative ‘bet’ fell this month and turned materially negative on risk, to its worst reading since Q2 and in the bottom quartile of back-tested history.

Four of the five sub-sectors are in the ‘bottom-left’ quadrant (growth below-trend and decelerating). Out of these, the key swing factor was Global Trade. We previously voiced concern that strong but temporary ‘front-loaded’ demand in Asian supply chains ahead of potential US tariffs on China would imminently drop off. The 90-day temporary truce on the tariffs announced earlier this month came too late for the sector to avoid a substantial fall in November, so it entirely erased gains seen in previous months.

Source: Fidelity International, November 2018

French protests add to weakness

Consumer/Labour also fell out of the ‘top-left,’ suffering from the recent creep upwards in US unemployment claims, compounded by weak French components - partly, but not entirely, the result of recent political protests.

Business Surveys and Commodities-related components have both failed to stabilise, looking similar to last month. The only positive sector is Industrial Orders, which rebounded strongly into the ‘top-right’ quadrant (growth above-trend and accelerating). Even here, enthusiasm comes with heavy caveats, as the improvement was driven by Japan’s Inventory/Sales ratio; however, this was due to technical revisions to the series, which has now been restated for the past year. US inventory/sales remain disappointingly flat, while Germany’s foreign orders are contracting - albeit showing some tentative signs of stabilisation.

Headwinds to global growth suggest caution on risk assets

There are plenty of headwinds this year to explain a continued softening in growth, despite some incremental improvements.

(1) US monetary policy continues to weigh on global growth via tighter liquidity, a strong USD, and ‘transmitted tightening’ into the EM complex. In this sense, the rising probability of a Federal Reserve ‘pause’ in 2019 provides a shard of optimism for markets. However, this may be offset by the US’s quickly-fading fiscal impulse.

(2) Oil prices have fallen significantly, which ultimately should prove a net positive for the global economy. That said, it would likely represent a drag on growth in the short-term; oil producers transmit their pain more quickly, before the boost to oil consumers wins out in a couple of quarters. Moreover, following OPEC’s supply cut, upside risks to oil may re-emerge.

(3) A Chinese slowdown persists, with no signs of game-changing domestic stimulus forthcoming. Conversely, China faces near-term headwinds from a fall in exports, as ‘front-loading’ of demand ahead of the former January 1st tariff deadline peters out.

With these in mind, the key factors to monitor in coming months are: Chinese credit conditions and activity; developments in US-China trade negotiations during the ‘90-day freeze’; the Fed’s tone on 2019 policy; signs of any meaningful slowdown in the US; and oil prices.

With ‘front-loaded’ trade demand waning, the FLI has pushed back expectations for global stabilisation deeper into 2019. The indicator points to below-trend and decelerating global growth both year-on-year and quarter-on-quarter. While the headwinds to global growth are rotating and may present tactical opportunities, the latest FLI suggests little reason to turn more positive on ‘beta’ more broadly for now, and again urges caution on risk assets.

Ian Samson

Ian Samson

Portfolio Manager