Goldilocks or the big bad recession?
Author: Kevin McCreadie
April 8, 2019
Equity markets have gotten a huge boost from the U.S. Federal Reserve’s (Fed) decision to stop raising interest rates for at least the rest of this year, but investors must not forget that weakening economic conditions are behind the central bank’s decision to pause.
While many believe we have entered a new “Goldilocks” period for stocks, the environment may not feel so right if the global economy continues to worsen and moves closer to recession in the weeks ahead.
Nowhere is the prospect of a downturn more evident than it is in Europe right now. Germany, the European Union’s (E.U.) biggest economy, has seen a steep decline in industrial production and its manufacturing sector is now in contraction, prompting the country’s leading research institutes to downgrade their growth forecasts for Germany’s economy to 0.8% from 1.9% in the fall.
In part, Germany’s economic woes are self-inflicted and relate to its struggling automotive industry. However, China’s recent slowdown is also playing a role and, more importantly, so too is Britain’s tumultuous and yet unresolved plan to exit the E.U.
Brexit has also taken a toll on both the French and United Kingdom’s economies and matters could get even worse in the case of a hard Brexit, whereby Britain leaves the E.U. without an agreement. Perhaps the best case scenario is a prolonged extension to the current departure deadline on April 12. But even then, it’s hard to see what would breathe much life into Europe’s economy at this late stage in the cycle. Unlike the Fed, the European Central Bank hasn’t been able to lift deposit rates out of negative territory to date and it has limited means of stimulus at its disposal.
Beyond the continent, cracks are also evident in the world’s two biggest economies. While the U.S. economy is supported by strong employment, low inflation – and now a Fed on hold – it can no longer rely on U.S. President Trump’s US$1.5 trillion in tax cuts and will continue to face trade headwinds as long as negotiations with China remain unresolved.
The Chinese economy is also beholden to a resolution with its largest trading partner, but may be in better shape to right its recent slowdown. The country has initiated another massive stimulus program that is starting to pay off, according to a Bloomberg Economic gauge that shows rising confidence in the outlook from investors, small businesses and sales managers.
To be clear, we still think all three of the world’s economic powerhouses can grow modestly and do not anticipate a global recession this year. But the fault lines that currently exist in Europe, China and the U.S. cannot be ignored by investors and given how strong equity markets have been of late, we’re most comfortable taking a cautious approach to stocks over the next few months.
Kevin McCreadie is Chief Executive Officer and Chief Investment Officer at AGF Management Ltd. He is a regular contributor to AGF Perspectives.
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