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Growing Pains

January 13, 2016 10:00

Growing Pains

We started 2016 with a wobble and the wobble is still reverberating around the markets. It may turn out to be a flash in the pan, from which we bounce smartly back, as we did during October 2014 and July and August 2015 ,but then again.

The main concern for investors in 2016 is the potential mismatch between Central Bank actions and the economic reality on the ground. This is particularly true for the USA and the Eurozone but also for Japan and China as well. In essence the issue for the markets is one of growth - Where will it come from? Will it be sustainable? How can we encourage it to stick around?

In the USA the Federal Reserve has started to tighten its monetary policy leaving the market to try and decide if and when further rate rises will be warranted. The Fed has suggested that it could rise rates four times in 2016 whilst the market has pencilled in two rises at most. It's likely that economic data will have the casting vote.

A good payrolls number but there are caveats

Last week December non-farm payrolls came in at 292k, well ahead of the consensus forecast. However caveats were soon applied, firstly that the number merely confirmed what we already knew i.e. that the US economy is very efficient at creating jobs. Secondly that wages did not grow significantly in December .Which in turn may mean inflation remains in the doldrums at least as far as the broadest measures are concerned. Also, because this was a December employment number, we need to consider that many of the additional jobs created were seasonal and could disappear over the course of Jan and Feb.

GDP up next

Q4 GDP data for the US is due to be released on the 29th of January. This is a preliminary read which may well be subject to later revision .The omens are not encouraging. Since the turn of the year we have seen a number of fourth quarter growth forecasts reduced. Among them those of Barclays bank, who moved from +1.1% down to +0.7% and the Atlanta Fed GDPNow model which also dipped to +0.7% from +1.9% on December 16th. The model, which is recalibrated by each relevant data release, has just moved back to a forecast +1.0%. However as we can see from the chart below, the models (which has been a relatively accurate gauge of Final GDP) estimations remain in a downtrend and well below the blue chip consensus forecast of Wall Street and others.

The chart shows the GDPNow US Q4 GDP forecast versus the blue chip consensus

Other side of the coin

Of course growth concerns are not limited to the major western economies or the developed world. Indeed the biggest concerns surround the fate of Emerging Markets and China whose fortunes are interlinked. International Monetary Fund chief, Christine Lagarde, warned of a new reality for Emerging Markets in a speech to French Bankers on Tuesday 12th Of Jan.

Ms Lagarde said that "Growth rates are down, and cyclical and structural forces have undermined the traditional growth paradigm," adding that "On current forecasts, the emerging world will converge to advanced-economy income levels at less than two-thirds the pace we had predicted just a decade ago. This is cause for concern."

Reading between the lines the implication is that EM economies can no longer count on a rapid return to growth even if the current malaise abates. Lower / slower growth rates in these economies will of course have a knock effect for the developed world. The IMF Calculates that 1% slowdown in Emerging Markets equates to a 0.2% fall in growth rates for advanced economies.

Ms Lagarde is not alone in sounding the alarm bells, US bond Fund Manager Jeffrey Gundlach, who manages a $52.3 bln total return fund, has warned that global growth could slow to 1.9% in 2016 as commodity and oil prices continue to slide.

If we look at the chart below, of the CRB Commodity Index, which tracks a basket of commodities, we can see that it has fallen well below the 2009 low point and is closing in on the 2002 lows. Effectively undoing all of the so called Super Cycle. Those 2002 lows, circa 150, could signal a bottom for the CRB Index. However if we look back to 1998/1994 we find the index printed down to 118 before bouncing. At the time of writing the CRB index stood at 162.

Chart shows the CRB Commodity Index performance over the last 15 years : 2009 lows in the red ellipse and the 2002 lows in the blue.

China conundrum

The deciding factor for the world economy in 2016 will be China, Wednesday morning saw the release of better Balance of Trade data from the People's Republic. However the bounce back in December 2015 could not disguise a 7% fall in Year on Year trade volumes, the fourth year in a row that this metric has missed its official target. Chinese imports fell 13.2% Year on Year, whilst exports fell by 1.4% in the period.

We should point out that exports for December came in well ahead of forecast and there was a slowing decline in imports on a monthly basis. Furthermore that when measured against the background of slowing global trade, on some metrics China actually out performed. The reality is that China is moving from a manufacturing led economy to one with a large services sector and that growth rates there are going to normalise, after years of out-performance.

We can think of this transition as the growing pains of a "teenage economy" ……. However we all know how difficult a moody teenager can be to deal with.

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