The current global economic downswing is expected here be more severe than the slowdowns in 2011-12 and 2015-16, for two reasons. First, global real narrow money growth fell to a lower level ahead of the current downswing than before the previous two. Secondly, both the stockbuilding and business investment cycles are expected to drag on activity – the prior slowdowns were mainly stocks-driven.
How is this forecast playing out? The first chart shows six-month / two-quarter changes in industrial output and GDP in the G7 economies and seven large emerging economies, with the latest data points referring to December and the fourth quarter respectively. Six-month industrial output momentum fell to 0.7% in December, the lowest since 2016 but well above troughs of -0.2% and -0.7% reached in 2012 and 2015. Two-quarter GDP growth, meanwhile, has also fallen but remains respectable, at 1.5% (3.1% annualised) in the fourth quarter.
With real money growth bottoming in October, a trough in economic momentum is unlikely to be reached until around mid-2019. Industrial output / GDP data, accordingly, are expected to deteriorate for a further six months, at least.
The second chart shows new orders / business components of the global manufacturing and services purchasing managers’ surveys, which supposedly offer a more timely read on economic activity. The final reading of the manufacturing new orders index for February was higher than suggested by earlier flash data but still represents the joint weakest (with January) result since 2012, i.e. undershooting a 2016 low. The services new business index remains solid but a positive divergence with manufacturing is normal in the early downswing phase – similar temporary resilience was displayed in 2012 and 2015.
The above series are coincident indicators of economic activity; the OECD’s composite leading indicators are useful for assessing short-term prospects. The third chart shows the deviation of G7 GDP from a statistical trend along with the OECD’s G7 leading indicator, including a January estimate (official data are released on 11 March). Based on the estimate, the decline in the indicator from a peak in February 2018 is already comparable with the peak-to-trough falls in 2011-12 and 2014-16. A caveat, however, is that the level of the indicator can often be revised significantly, as trends in the individual components are reestimated to incorporate new data. This caveat is less relevant for the direction of the indicator, which has yet to suggest any bottoming out of economic momentum.
As noted above, business investment is expected here to show greater weakness this year than in 2011-12 and 2015-16. The fall in the global manufacturing PMI new orders index was led by the investment goods component, which moved well below its 2016 low in January, though recovered in February – fourth chart. Recent weakness in intermediate goods orders, meanwhile, is consistent with the stockbuilding cycle moving further into its downswing phase. Consumer goods orders remain solid but – as with services activity – such resilience is not unusual in the early stages of an economic downswing. Consumer weakness typically emerges as slowing activity feeds through to labour markets.
The business investment and profits cycles are closely linked. The fifth chart shows national accounts-based estimates of gross domestic operating profits (EBITDA). Japanese and UK profits contracted in the year to the fourth quarter, while Euroland growth was the weakest since 2013. US fourth-quarter numbers have yet to be released: year-on-year growth is likely to remain solid but the level of profits may have stepped down last quarter, judging from S&P 500 earnings reports.
Profits are very likely to remain under pressure during the first half from slowing activity, weak pricing power and rising wage costs due to high settlements and excessive hiring in 2018.
In summary, coincident and short leading evidence has yet to confirm the forecast of a more severe economic downswing than in 2011-12 or 2015-16 but indicators are behaving largely as expected, allowing for the usual leads / lags. If correct, the next phase of economic weakness will involve corporate retrenchment extending from fixed investment and stocks to hiring, undermining consumer confidence and spending and leading to a further deterioration in business sentiment.