Global economic outlook and investment implications

Brexit, trade tensions, global slowdown: The themes are familiar, but the stakes are getting higher.

global economy 88 (photo credit:)
global economy 88
(photo credit: )
Instead of a calm end to summer, the past few months have brought more downside risks for the global economy.  The US and China mutually raised tariffs, while evidence of a slowdown in the eurozone is accumulating.  Brexit outcomes have become even more difficult to predict. Civil unrest in Hong Kong and a rebuilt governing coalition in Italy are the latest examples of imbalances seen around the world.

The ongoing uncertainties will continue to weigh on economic prospects for the remainder of the year and into 2020.  Fortunately for the US, the economy is 70% consumer driven and only dependent for around 10% of gross domestic product (GDP) on foreign trade. Being relatively independent of other economies – and with the US consumer in a very strong financial condition -- the American economy is largely unaffected by the global slowdown in growth to more modest levels and the trade wars. The buoyant equity markets have fully reflected this reality, and many believe it has far further to go – albeit in a turbulent manner.

The global economy continues to expand, but the outlook is less positive than it was a year ago. Then, a synchronous upswing had emerged for the first time since the global financial crisis. Over the course of 2018, however, the momentum of key economies began to diverge. The US and Indian economies continued to accelerate, but economic growth slowed in China, the European Union and Japan. Last year also marked the beginning of a new deceleration trend. In 2019 and beyond, all major economies except India will experience slowing growth rates. While parts of the US economy, including business investment, are sluggish, the hale and hearty US consumer is encouraging. Backed by a solid labor market, the Conference Board Consumer Confidence Index reaffirms that consumers are willing to spend.  

Over the past few decades, business — especially manufacturing — has taken advantage of generally open borders and cheap transportation to cut costs and improve global efficiency. The result is a complex matrix of production that makes the traditional measures of imports and exports somewhat misleading. For example, in 2017, some 37% of Mexico’s exports to the United States consisted of intermediate inputs purchased from . . . the United States. 

Recent events appear to be placing this global manufacturing system at risk. The United Kingdom’s increasingly tenuous post-Brexit position in the European manufacturing ecosystem, along with ongoing negotiations to replace the North American Free Trade Agreement, may slow the growth of this system or even cause it to unwind. 

A challenge now facing the global trading system is the unpredictable tit-for-tat explosion of trade restrictions between China and the US. The real issue is the uncertainty about the tariffs and the US government’s goals in imposing these taxes. White House trade adviser Peter Navarro argues that the tariffs are necessary to reduce the US trade deficit and to help the United States strengthen domestic industries such as steel production for strategic reasons. This suggests that tariffs in “strategic” industries could be permanent. But commerce secretary Wilbur Ross has stated that the goal is to force US trading partners to lower their own barriers to American exports. That suggests that the administration intends the tariffs to be a temporary measure to be traded for better access to foreign markets.

Many companies face the possibility of a significant change in border-crossing costs — as would occur if the United States withdrew from NAFTA without adopting its replacement, the United States-Mexico-Canada Agreement, or made tariffs on Chinese goods permanent. This could potentially reduce the value of capital investment put in place to take advantage of global goods flows. Essentially, the global capital stock could depreciate more quickly than our normal measures would suggest. In practical terms, some US plants and equipment could go idle without the ability to access foreign intermediate products at previously planned prices.

With this loss of productive capacity would come the need to replace it with plants and equipment that would be profitable at the higher border cost. We might expect gross investment to increase once the outline of a new global trading system becomes apparent.

In the longer term, a more protectionist environment is likely to raise costs. That’s a simple conclusion to be drawn from the fact that globalization was largely driven by businesses trying to cut costs. How those extra costs are distributed depends a great deal on economic policy. For example, central banks can attempt to fight the impact of lower globalization on prices (with a resulting period of high unemployment) or to accommodate it (allowing inflation to pick up).

Whatever happens, the tariffs are unlikely to have a direct impact on the US current account, except perhaps in the very short run. The current account is determined by global financial flows, not trade costs. Any potential reduction in the current account deficit is likely to be largely offset by a reduction in American competitiveness through higher costs in the United States, lower costs abroad and a higher dollar. In fact, despite the impact of a wide variety of tariffs on American imports over the past two years, the US trade deficit has increased substantially, from a seasonally adjusted monthly rate of around $46 billion in January 2017 to $55 billion in June 2019. The evidence is clear that the tariffs have not reduced the country’s trade deficit.

Adding to the problems in the trade sector, growth in Europe and China has clearly slowed. These are two of the three regions that drive the global economy (the third is the United States). Slow growth abroad is very likely to translate into slower growth in US exports and perhaps a higher dollar, further slowing export growth. 

Brexit is an immediate issue in the short run, although it does not affect the medium- or long-term US outlook that much. A hard Brexit is unlikely to significantly affect US sales abroad directly. But it could help soften overall European economic growth even further, providing yet another headwind for American exporters. The US economy, however, has shown resilience and adaptability when similar situations have occurred; and it is likely that when the uncertainty elements have been clarified, robust economic growth will resume.  Keep in mind Warren Buffett’s famous quote: “For 240 years it’s been a terrible mistake to bet against America, and now is no time to start. America’s golden goose of commerce and innovation will continue to lay more and larger eggs.”

For investors, US equities still provide a compelling alternative to bonds. Corporate earnings are strong and accelerating, and inflation is benign. Businesses are benefiting mightily from the digital revolution, which enhances profitability by constraining costs and facilitating efficiencies. Low interest rates are favorable tailwinds for equity valuations, and current earnings and dividends are attractive relative to other investment alternatives. Diversified portfolios of select dividend-paying stocks ought to be a core holding of those seeking growing income.

Selwyn Gerber is a CPA, economist and personal financial planner. Based in Los Angeles, he co-founded RVW Wealth LLC 15 years ago.
David Zwebner is the founder of Commstock Ltd. registered investment advisors and portfolio managers. Based in Jerusalem, Commstock exclusively represents RVW in Israel.