At GAM Investments’ latest Active Thinking forum, Michael Biggs discusses key themes in markets, including the outlook for China, the European energy shock and whether the US is likely to go into recession.
15 July 2022
Michael Biggs – Global Macro & EM Debt
We entered 2022 with a fairly bullish view, which was met by three major events: the sharp increase in US policy rates, the war between Russia and Ukraine, and lockdowns in China in response to the Omicron variant. Despite the uncertainty caused by these events, we believe there is a possible avenue to a more bullish environment.
Of these three events, the one we view most positively is the China story. Growth was improving towards the end of 2021 and early 2022, before lockdowns caused by Omicron were implemented. The Goldman Sachs Global Effective Lockdown Index is now falling, albeit steadily. In the past, when it has fallen, the growth numbers have tended to surprise to the upside. Although we are seeing infections increasingly in various regions in China, the Chinese authorities are becoming increasingly successful at implementing micro-lockdowns where required, and so the Lockdown Index continues to improve.
In our view, the big story relates to China policy. In 2020, credit growth picked up in China, the credit impulse was very positive and as a result, China surprised to the upside. In 2021, China tightened, the credit impulse turned negative, the property sector came under real pressure and everything surprised to the downside. At the end of 2021, the credit numbers improved again and then fell sharply in April due to Omicron. Following a large local government bond issuance number in May and strong total social financing in June, we are also seeing an upside surprise to economic activity in China. As a result, property sales may start to stabilise and pick up. There has already been a reasonably sharp rebound in the Purchasing Managers’ Index (PMI), and prior to the emergence of the Omicron variant, we saw improvement in retail sales and fixed asset investment. Investors are currently bearish China with the scope for upside surprise. Indeed, over the last two months, Chinese stock markets are up approximately 15% while stock markets across the rest of the world are down. China tends to have slightly more control over its economy than others tend to anticipate and if that materialises and leads to better growth numbers, this will not only be good for China, but also for Asia, exporters to China and commodity producers. The latest China inflation number was 2.5%, which is not high enough to warrant concern about the inflation outlook, in our view.
The worst story, in our view, is that of Europe. At present, it is very difficult to see a positive outcome in relation to energy prices in the Euro area. Entering 2022, we thought the underlying macro fundamentals for Europe were excellent but with the energy shock, we see it as extremely uncertain.
With regards to the US, the most concerning question is whether the economy will go into recession. Growth forecasts from the Federal Reserve (Fed) Bank of Atlanta are negative for the second quarter, after also being negative in the first quarter of 2022. However, recent ISM and payroll numbers have somewhat reduced fears of a recession. At the same time, the underlying components were not particularly strong. On the ISM side, the new orders index for manufacturing fell below 50. Notably, it has previously fallen below 50 without experiencing a recession. This alone then is not reason to panic, in our view, but it is still a point of concern. In the face of this data, we continue to believe that a slowdown in the US is more likely than a recession, but the difficulty is assessing whether the slowdown becomes a recession.
Our expectation of a slowdown rather than a recession is based on our assessment of a range of credit indicators. Currently we are seeing a rise in new borrowing and if this continues, the positive credit impulse will drive above-trend demand growth. If something happens causing new borrowing to fall, such as an increase in real interest rates, the economy may be plunged into a recession. Notably, the current borrowing level is not nearly as high as it was before the last recession, or even the four recessions prior to that. In our view, the most important indicator to monitor is the senior loan officers survey. Presently, credit standards have stabilised after a period of easing – this stabilisation is consistent with growth and still above trend. With the next senior loan officer number coming in August, other monthly indicators, such as bank lending numbers are useful to assess. These numbers are currently rising, which does not suggest a sharp tightening in credit leading to a recession.
From a sector perspective, we expect the US housing market to slow down and we do not believe the sharp increase in house prices can be maintained. These high house prices are a product of low completed homes relative to sales, with many homes under construction – giving the perception of a tight housing market. The number of homes under construction has been growing by 40% year-on-year, so the number for sale should pick up once these are completed. The greater housing inventory combined with a small reduction in construction should see house prices come down and take some pressure off rental inflation, in our view.
Business capital expenditure is also pointing away from a recession. Business borrowing and investments are rising, which is not normally an environment that tends to see a recession. The economy over the last two years has been characterised by bottlenecks. Investments have been made in order to try to overcome these and new borrowing also seems to be increasing to meet this need. This borrowing is typically comings from banks in the form of loans. The latest bank numbers, which are released weekly, show that such loans are still increasing. Therefore we expect to see increased borrowing by firms, a slowing of the housing sector, which reduces growth, counteracted by fairly resilient capital expenditure and resilient consumers – with payroll numbers suggesting decent income growth. Ultimately, this all remains uncertain, but if we see signs the US will stabilise and not going into the recession path, along with an increase in Chinese growth, then the environment will start to look positive, in our view.
The bearish view remains that despite good growth, the only way inflation can come down is as a result of a recession – the Fed would hike more in response to good growth, making a recession more likely. In our view, inflation may come down because of a recession due to supply consumption and so, previously the only way to tackle inflation was to bring demand down heavily. We now view a smaller decrease in demand and increase in supply to be supportive of inflation coming down and growth being more resilient.
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The information in this document is given for information purposes only and does not qualify as investment advice. Opinions and assessments contained in this document may change and reflect the point of view of GAM in the current economic environment. No liability shall be accepted for the accuracy and completeness of the information. Past performance is not a reliable indicator of future results or current or future trends. The mentioned financial instruments are provided for illustrative purposes only and shall not be considered as a direct offering, investment recommendation or investment advice. The securities listed were selected from the universe of securities covered by the portfolio managers to assist the reader in better understanding the themes presented and are not necessarily held by any portfolio or represent any recommendations by the portfolio managers. There is no guarantee that forecasts will be realised.