The next recession

It’s that time in the ebb and flow of global commerce that investors cast around for the next big threat to the economy, the unforeseen wave that will upend everything.

Economists and talking heads have pitched up quite a few candidates over the past six months: China, the US housing market, China, business debt, emerging market debt, China, and now a German recession. Germany has been an unbelievably solid operator for the past eight years or so. The rest of the Continent has been roiled by near-defaults, political strife and profligate people and representatives. All the while, the engine room of the single market has steadily hummed along like the cars and trucks rolling ceaselessly off its production lines. German unemployment has been hammered down to just 3.3%, while real wage growth has been positive since 2014 – it got as high as 2.5% between 2015 and 2016. Meanwhile, the nation has been stacking cash like never in its history: its current account surplus (the amount of money flowing into the country from trade and profits from overseas investment less that spent on imports and paid to foreign investors on German assets) is running at a huge 8% of GDP.

Lately, however, investors have begun to worry that all may not be well with the Germans. Manufacturing output has fallen recently and construction activity hasn’t been as chipper either. GDP growth dipped sharply in the third quarter of 2018, putting the nation at risk of posting a technical recession (two quarters of contraction rather than growth). This brings more pessimistic scrutiny of its current surplus. While it’s always advisable to spend less than you earn, such a hefty surplus can be read a different way: the nation is heavily dependent on exports, making it highly sensitive to worldwide growth, and its people aren’t spending their hard-earned cash. Concerns about a global slowdown are legion at the moment and quite a few investors are starting to see hoarding Germans akin to survivalists stocking up ahead of the apocalypse. This sort of mood is what has sent the German 10-year government bond yield slumping to 9 basis points (a few weeks ago it was 30bps).

It doesn’t help that German unemployment measures tend to shoot higher in January with the regularity of a heartbeat, so worriers will have plenty of short-term numbers to spook themselves with. Also, new emissions standards caused a dip in production too, so it’s difficult to determine where the regulatory hiccup ends and real problems begin. It will be important to keep an eye on Germany, but investors have been very quick to find the next big risk lately. They’ve found more than you could count on two hands in the past few months, causing pain in stock markets, and yet Armageddon has stubbornly refused to arrive.

Source: FE Analytics, data sterling total return to 8 February 2019; *closed for Chinese NY, data to 31 January

Boom? Gloom?

Speaking of slowdowns, UK GDP growth decelerating dramatically in the fourth quarter. Perhaps the distinct drop in output was due to workers round the country downing tools to watch the national soap opera that is Parliament’s Brexit Time.

British industrial production was the main culprit for the 0.2% quarter-on-quarter growth, with factories producing less than in the previous three months. The annual rate of growth was a paltry 1.2%, the lowest pace since 2012. Construction was weaker as well, while consumers are still looking cautious. Services, by far the largest employer for the UK, grew at a more reasonable 0.4% rate.

For all the jokes, Brexit is the perennial villain when it comes to why the UK has slowed over the past few years. More negotiations over the compromise deal with the EU will continue to wend onward this week and no doubt for weeks, months and years to come. Unfortunately, Brexit is far from a one-front battle. As the FT has pointed out, there are many other agreements being hatched in the background to ensure we can trade and deal with nations outside of the EU. One of which is with Japan, an important supplier of metal. At the moment, we benefit from being an EU member giving us low-tariff trade and simple dealings. However, Japan is driving a hard bargain with a solo Britain, apparently trying, prudently, to extract every possible concession. We very likely will end up with a less-beneficial post-Brexit agreement. You could give yourself a chill wondering how many of the other negotiations with the great wide world outside the EU are going. It seems unlikely that they would be going any better than the one with the EU or Japan. Just think of how it’s going with the Donald’s administration …

But hey, the US President is probably too wrapped up in different problems to stir up diplomatic problems for us. The US economy is doing ok, but could be turning over, so the stock market has been exceptionally schizophrenic. During his presidency, Mr Trump has seen the S&P 500 Index as a way of keeping score, of assessing the virility of his leadership. That leads many people to believe that he will, in the end, come round and talk terms with the Democrats in Congress (to avoid another government shutdown) and China (to avoid a global recession). He is refusing to speak with both at the moment, but investors seem optimistic that he will come around.

US mom and pop companies are perhaps less sure. The NFIB Small Business Optimism Index has been looking a bit worse for wear recently. Small businesses have been exceptionally confident since Donald Trump was elected President in late 2016, but the NFIB index has come off the boil. It remains high, but is expected to sag yet more when the next print is released on Tuesday. Despite this, hiring by these smaller businesses has actually been strengthening over the past month.

Everywhere you look there’s both reason to be confident and worried. Our advice? Keep an open mind and try not to simply reinforce what you already believe. It’s a dangerous time to give in to confirmation bias.

 

Bonds

UK 10-Year yield @ 1.15%

US 10-Year yield @ 2.63%

Germany 10-Year yield @ 0.09%

Italy 10-Year yield @ 2.96%

Spain 10-Year yield @ 1.23%

 

Economic data and companies reporting for week commencing 11 February

 

Monday 11 February

UK: GDP, Private Consumption, Trade Balance, Industrial Production, Construction Output, Index of Services

US: MBA Mortgage Foreclosures and Delinquencies

 Final results: Acacia Mining

Trading update: Up Global Sourcing

 

Tuesday 12 February

UK: BoE Governor Mark Carney speaks in London

US: NFIB Small Business Optimism, JOLTS

 Final results: Plus500

Quarterly results: TUI

Trading update: AA, Loopup Group

 

Wednesday 13 February

UK: CPIH, CPI, RPI, PPI, House Price Index

US:  MBA Mortgage Applications, CPI, Real Average Weekly Earnings, Monthly Budget Statement

EU: Industrial Production

Final results: Smurfit Kappa Group, Tullow Oil

Interim results: Dunelm Group, Galliford Try

Trading update: RWS Holdings, Time Out Group

 

Thursday 14 February

UK: RICS House Price Balance

US: PPI, Retail Sales, Business Inventories

EU: Employment, GDP; GER: Wholesale Price Index, GDP

Final results: Attraqt Group, AstraZeneca, Coca-Cola HBC, Indivior, Micro Focus International, Moneysupermarket.com

Interim results: Ashmore Group, MJ Gleeson

Quarterly results: Safestore

Trading update: Trifast, UK Commercial Property REIT

 

Friday 15 February

UK: Retail Sales

US: Empire Manufacturing, Trade Balance, Industrial Production, University of Michigan Sentiment Survey, Net Long-Term International Capital Flows, Capacity Utilisation, Manufacturing Production

EU: EU 25 New Car Registrations, Trade Balance

Final results: Millennium & Copthorne Hotels, Royal Bank of Scotland Group, SEGRO

Total votes: 17