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China’s economy is likely to contract in Q1
At least two-thirds of China’s economy is likely contracting on a sequential basis due to capacity closures and travel restrictions. It’s not clear how quickly the economy will rebound in the coming months.
This is both a demand and supply-side shock to the global economy
The demand-side losses are easier to quantify than the potential supply-side shocks. Plus, these shocks will interact in uncertain ways. Increased uncertainty may weigh further on global capex, especially as the virus spreads internationally.
Chinese policymakers are focused on continuity, not growth targets
For now, China’s policy priority is to maintain the stability of the supply side in the face of a severe demand-side shock. If these efforts are successful, we doubt a larger, demand-side stimulus will be forthcoming.
Corporate profits are in recession
Corporate profits have fallen over the last 12 months. A squeeze to profit margins has been entirely responsible. But the consensus expects a recovery over the remainder of 2020. The bottom-up consensus is for 9% EPS growth.
Rising wage growth is squeezing profit margins
That looks too optimistic to us. Margins have come under pressure as wage growth has picked up across much of the OECD. Profits growth will remain weak unless nominal GDP and/or productivity growth pick up substantially. Both seem unlikely.
Earnings expectations look set to be disappointed
At a minimum, earnings forecasts are likely to be disappointed this year. It’s possible that inflation picks up as firms raise prices to restore margins. But with pricing power mostly lacking, many might need to alter their hiring and capex plans.
Climate change is increasingly playing on investors’ minds
Climate change, and its effects, is likely to be a defining investment theme for the next decade at least. Institutional investors are becoming increasingly aware of both the risks and opportunities that this presents to their portfolios.
An onus on technology emphasises R&D and infrastructure investment
Technological improvements in the heat and electricity sector have led the way in reducing the cost of decarbonising power. Other GHG emitting sectors such as transportation and agriculture could benefit from similar R&D investment.
But a protectionist reaction could offset this positive fiscal shift
Investment does not have to come at the expense of lower growth. Governments could incentivise investment with fiscal expansion. But efforts to prevent ‘carbon leakage’ could backfire if they are perceived as protectionist.
Markets expect the removal of uncertainty to boost global growth
Business sentiment has improved further in the past few months, on the back of reduced trade tensions and lower policy uncertainty. It seems markets expect the removal of tail risk to spur an upturn in global growth.
Corporate spending drives the cycle, and there are some positive signs
As we’ve outlined before, corporate spending is the key driver of the business cycle. Capex intentions have picked up across developed markets, and residential investment could provide a boost in the US in the next few quarters.
But the deteriorating earnings outlook will dominate
But with earnings growth slowing further in the past few months, and with our models pointing to a 5% contraction in global earnings this year, we’re sceptical that we’ve reached a major turning point in the global capex cycle.
The ‘phase one’ US-China deal removed a near-term tail risk
A temporary truce is better than an escalating trade war, and the phase one US-China trade deal has helped to support risk assets and business confidence since the outline of the draft agreement first emerged in October.
But at the cost of trade diversion and weaker Chinese growth potential
The only significant outcome of the deal looks to be a shift towards managed trade for China. This may disrupt global trade in the near term, and increased state intervention is likely to weigh on Chinese growth in the longer run.
Markets may be underestimating the deal’s fragility
We doubt the deal will survive its two-year implementation period. The dispute resolution mechanism is likely to lead to a breakdown. The risk of re-escalation has not been eliminated, just supressed.
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