John Stopford, (pictured) Portfolio Manager, Investec Diversified Growth Fund asks is US growth about to turn up. He writes that since the Global Financial Crisis, economic growth has disappointed in most regions.
Whether it’s been due to fears of a break-up of the euro zone, entrenched deﬂation in Japan, falling oil prices in Canada, Russia and the Middle East, an overhang of unsold property in China, or just structurally slower global population and productivity growth, the world economy has been held back by a series of headwinds.
Against this backdrop, the US has tended to be a relative bright spot — an engine of global growth which is several years ahead of other economies in its post-crisis balance sheet repair process. The US has recently shown some signs of much softer economic activity, notably in industrial production, which has weakened materially. The question is whether this is enough to derail the broader US economy.
The fear amongst investors has been that the US recovery will be fatally undermined by manufacturing weakness. A more optimistic scenario is that strong consumer real income growth and reasonably resilient service sector activity will support demand long enough for manufacturing to recover. This is beginning to look a little more likely.
By itself, industrial production is not a big component of the US economy. Together, manufacturing and mining contribute 12 per cent and 1.5 per cent to overall GDP, respectively. The latter has been hit hard by the collapse in oil prices, but the mining sector represents only 0.5 per cent of non-farm payroll jobs. While the direct effects of a drag from energy production are probably small, they could have more far-reaching implications for the wider economy, by accentuating global ﬁnancial market jitters, or through the large size of the falls in activity and their knock-on impact to other sectors such as consumer spending, especially in the US where the shale boom has been signiﬁcant.
Yet other indicators remain more encouraging. Markit’s composite purchasing managers index of US activity for February fell sharply, suggesting that the American economy continues to weaken, but there are reasonable grounds to suggest that this indicator is possibly pointing the wrong way. Two other organisations publish similar series – the Institute for Supply Management (ISM) and the National Association of Credit Managers. Both have a much longer history than Markit’s measure, especially the former, and have been much less volatile in recent years. Both were also broadly stable in February and up from their recent lows.
Within these composite series, the ISM manufacturing index has the longest data set. Its recent trend is encouraging and may be starting to point to better growth ahead for the US economy. Two aspects in particular are reassuring. Firstly, the New Orders component, which tends to lead production, turned up a month ago and has now been above 50 for two months, implying renewed expansion. Furthermore, the ISM manufacturing index tends to exhibit cycles of slowdown followed by rebound linked to inventory cycles. The latest period of slowing fits the pattern seen over the last two and a half decades almost perfectly and suggests manufacturing may be turning up, right on cue.
In addition to the impact of dollar strength, falling equity prices and higher borrowing costs for sub-investment grade corporate bond issuers are increasing the likelihood that growth will slow further, although some offset comes from the continuing rise in property prices. Measures of lending conditions suggest that although ﬁnancial conditions have tightened somewhat in the US, the extent has been relatively limited, particularly when compared to periods proceeding previous recessions.
Analysis of the implied probability of a recession estimated solely from changes in composite lending conditions shows that while the chances of a recession have indeed ticked higher, the level appears to us consistent with a modest slowdown, rather than a material decline. Other leading indicators of growth — such as consumer conﬁdence, unemployment beneﬁt claims, and manufacturing and non- manufacturing new orders — also point to a similar conclusion.
From a review of evidence, therefore, it appears that the US economy is most likely going through a period of slower growth, with a low probability that we are on the cusp of another recession. If this is true, then ﬁnancial markets have overreacted to the signs of weakness and should ultimately bounce back. Only if the weakness in global ﬁnancial markets ﬁlters through into much weaker business and consumer conﬁdence, will the market’s fears be realised. At present, we see little evidence that this is happening.