Following a flood of warnings in the past week about both the precarious state of markets and the global economy, most recently from the otherwise stoic Howard Marks warning about bubble-like condition in the market (especially when it comes to passive investors), as well as Robert Shiller who explained what "keeps him up at night", we were due for some good news. It came over the weekend courtesy of Morgan Stanley's co-head of economics, Chetan Ahya, who writes in his Sunday Start weekly piece that "2017 is unlike 2012-2016" - a period characterized by an economy that rebounded on several occasions, prompting several narratives of "false starts", only to see the global recovery fade and keep central banks stuck in printing mode.
In other words, this time - Morgan Stanley predicts - will be different. We are not so confident.
Here is Morgan Stanley's explanation why this time the handoff from central banks to the private sector should work out:
Why 2017 is unlike 2012-16
Over the last five years, the global economy has been through a number of wobbles. Initially, DMs faced unprecedented deleveraging headwinds. Subsequently, China and other EMs underwent a period of deep adjustment. The outcome was a global expansion that was un-synchronous and heavily dependent on policy stimulus, which has been reflected in years of below-par growth. From 2012 to 2016, global GDP growth has averaged just 3.3%Y and more recently, since 2Q14, global GDP growth has averaged just 3.2%Y, well below the long-term average of 3.5%Y.
That was then. Fast forward to today, global growth is tracking at its fastest pace since 2Q14. The growth has been broad-based, with upside surprises in Europe and China. While we do expect some moderation in growth in 2H 17 from the current high levels, full year global GDP growth is estimated at 3.6%, which would be the strongest rate of growth since 2011. Moreover, at the current juncture, global growth is tracking better than what we have built in for the full year (2017), principally due to a stronger than expected outturn in 2Q.
There are a number of factors which differentiate this year versus the preceding five years. First, both DM and EM growth is accelerating for the first time since 2010, and within that, the recovery has been broad-based across individual economies too. Second, global trade in value and volume terms is also growing at its strongest since 2011. Third, the global investment cycle has also improved meaningfully, as global ex-China gross fixed capital formation grew at the fastest pace in 1Q17 since 1Q15 in %Y terms and in a broad based fashion. Finally, while the strength of the recovery is similar to that of 2010-11, it is important to note that the recovery was, to a large extent, driven by base effects and was therefore somewhat statistical in nature as it reflected a recovery from a deep recession and that recovery was driven by aggressive monetary and fiscal expansion in both DM and EM. When evaluated against this context, global growth is currently tracking at the best rate since the 2003-2006 cycle.
Despite the recent strength in global growth, our conversations indicate that there is still a fair bit of skepticism. The three key debates are:
1) Will tightening by DM central banks cause a sharp slowdown?
Investors contend that the recent subdued inflation prints are pointing towards some weakness in aggregate demand and the planned removal of monetary accommodation by DM central banks will hurt the recovery.
However, we think that private sector risk attitudes are normalizing, as deleveraging pressures are now behind us. Indeed, within G4, the non-financial private sector has been leveraging up for the past 4 quarters and fiscal policy is not tightening as it was between 2011 and 2015. As the private sector takes on a greater role in driving growth, monetary accommodation can be gradually rolled back without causing a sharp slowdown in growth.
2) Will a weakening of credit impulse in China weigh heavily on growth?
As regards China, investors are concerned that the recent cyclical strength has been due to past policy stimulus and with policy makers now dialing back the stimulus, growth would decelerate sharply as it did during 2013-15, creating challenges not just for China but would also weigh on the rest of EMs and global economy.
There are three offsets to this policy tightening. First, external demand is recovering after five years of deceleration and the contribution of net exports to growth has turned positive. As exports growth is recovering, policy makers in China – who tend to run a counter-cyclical growth model – are relying less on debt-fueled public investment demand, which is resulting in a paring back of aggregate credit growth. Moreover, private sector investment and private consumption are improving, which is lending support to the ongoing recovery. In the property market, inventory levels have been declining rapidly and even though property purchase restrictions have been tightened, the property market is unlikely to require or experience that depth of adjustment that it experienced in 2013-15.
3) Is recovery in EMXC just about commodity price improvement and China?
The third debate revolves around the impact that stimulus in China has had on other EMs via a boost to commodity prices. As China withdraws its stimulus and commodity prices reverse, growth in EMXC will decelerate.
In our view, the recovery that is underway in EMXC is not just about commodity prices. Indeed, both commodity exporters and importers have had a recovery in growth. More fundamentally, the majority of EMXC have had to undergo a period of adjustment (payback), as they had pursued unproductive expansionary policies post 2009, which resulted in elevated macro stability risks. This adjustment is now completed in most of these EMs and hence a gradual recovery is now underway.
To be sure, there are still risks to global growth, particularly in DM as they are more advanced in the business cycle. In that context, if DM central banks tighten even more aggressively than we are building in, it could weigh on growth. In China, we are watching risks to growth that could emerge if policy makers take up more aggressive tightening from 4Q17 post the 19th Party Congress.
Our base case is that global growth will moderate somewhat in the coming quarters from the current high run rate, but will settle on average at above trend for both 2017 and 2018. In other words, the experience of the past five years is unlikely to be a good guide for what will unfold next in the global economy. Reflecting this broad-based, synchronous global recovery, our strategists continue to recommend US and Japan as our preferred equity markets, and have a preference for EM fixed income over US credit. In currencies, they like owning USD against low-yielding currencies like CHF and JPY and selling it against EUR, and select EM currencies like PLN, IDR and MXN.