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Macro Market Research

Updated: Jan 30, 2019

Authors: Jerusan Jegatheeswaran Co-VP Research, Dragos Cada Co-VP Research, Alice Li Research Analyst, Matthew Morgan Research Analyst


Global Economic Growth Update


World Economic Growth

According to the International Monetary Fund (IMF), world economic growth will slow in 2019. The IMF cut its outlook for global growth for this year to 3.5% and 3.6% in 2020, down from the 3.7% they had projected this past October. The major risks cited were a larger than expected decline in China’s economy, trade tensions, weakness in Europe and some emerging markets, rising interest rates, and a potential “No Deal” Brexit that could cause major turbulence in the markets.


China

Indeed, worries about China’s economic health have been known to add fuel to major sell-offs in the financial markets globally. During the 2015-16 stock market sell-off, the Shanghai Stock Exchange Composite Index saw a 48.6% drop from its peak on June 12, 2015 through the end of January 2016. The main concerns where a slowdown in China’s GDP growth along with the Greek debt default in June 2015, and the United Kingdom European Union membership referendum of 2016, in which Brexit was voted upon. The major shocks happened around July 27 July and 24 August's "Black Monday" and the Shanghai stock market fell by about 30% in a three-week period.

Source: Yahoo Finance

Shocks were felt in markets on the other side of the globe as well. On Black Monday, the Dow Jones Industrial Average, a US market index, experienced its largest drop in history, losing 1000 points at the opening.

Source: Yahoo Finance

Is this a reason to worry about global market performance in 2019? If recent reports on China are anything to go by, then perhaps we should be concerned. On Monday, China reported 6.6% economic growth in 2018, its lowest since 1990. Also, China’s exports unexpectedly decreased in December by 4.4% year over year due to weakening demand while imports fell 7.6% which marks their biggest decline since July 2016.

However, there was positive growth figures to note. Industrial output growth was 5.7% in December year over year, 40 basis points (bps) higher than economists' expectations of 5.3% growth and 30 bps higher than November's 5.4% growth. In addition, retail sales grew 8.2% in December from a year earlier, matching forecasts and up from November's 8.1% growth.


With reports of slowing growth comes questions about whether the nation will insert some stimulus into its economy, given the potential for job losses. Policymakers in China have displayed a willingness to introduce some support but warned that a flood of stimulus, while improving growth rates, would leave the country with massive amounts of debt. Chinese policymakers have already introduced some stimulus so far in the form of tax cuts, import duties and fast-tracking construction contracts in an attempt to increase demand.


While more stimulus is expected to arrive soon, it likely won’t massively boost growth as the effects of the trade tensions in the US still way on China’s economy. "What China can really do this year is to prevent deflation, prevent a recession and a hard landing in the economy," said Chen Xingdong, Chief China Economist at BNP Paribas. For the upcoming annual parliament meeting in March, analysts speculate that the government may bring further tax cuts and increased spending on infrastructure projects in further attempts to boost growth.


Brexit

Last week, Britain’s Parliament has delivered a crushing verdict on Prime Minister Theresa May’s Brexit divorce deal, rejecting it by 432 votes to 202 – the biggest defeat suffered by a government in modern British political history. Immediately after Tuesday’s vote in Parliament, a no-confidence vote was called in the government and May survived. On Monday, May revealed her plan B which is only a little different from plan A. In terms of her details, she will be going back to Brussels, to seek some amendments to her initial agreement. This needs to be done in order to get a plan through another vote in the commons. Looking at some of the GBP bullish takeaways from this statement; she guaranteed rights for EU citizens at several angles, scraping the application fee EU nationals registering in Britain, discussing the backstop with the Democratic Unionist Party this week. Just two months before UK is due to leave the bloc, May added that the exit is unlikely to be delayed and she will press on with effort to get an EU divorce bill approved by parliament.


GBP/USD

Pound Sterling trades towards the top end of a multi-week range against the Dollar and Euro thanks to a combination of positive economic data and developments that suggest a 'no deal' Brexit will be avoided on March 29. The Pound-to-Dollar exchange rate is quoted at 1.2917 while Sterling is seen trading higher against the majority of the world's ten largest currencies.

May appeared keen in her language to ensure of a soft-Brexit, rather than one that is hard, when she revealed her plan B. This supported GBP in its push to session highs, at the time, briefly moving back above 1.2900. Goldman Sachs Chief Economist Jan Hatzius now speaks about the Brexit issue. He mentioned that there is only 10% chance of hard Brexit.


Apart from the optimistic news of Brexit, better than expected UK jobs data further improved the sentiment. Wages rose 3.4% where markets had been expecting a 3.3% increase. The unemployment rate meanwhile unexpectedly fell 10 bps to 4.0%. The Pound received a boost Tuesday morning after the report of such strong labour market data that appear to fly in the face of the general gloomy consensus on the economy in light of ongoing Brexit uncertainty.


UK Equities

Speaking of the stock market in UK, analysts tend to all agree that the market is going to perform well in 2019. It is currently at its low point. FTSE 100 tumbled 12.5% in 2018 and underperformed relative to its global peers. The index is already trading at levels last seen in December 2016 and even languishes below the high reached at the climax of the technology bubble in December 1999.

Investors’ concern about the negative effect of Brexit, especially a no-deal Brexit and the depreciation of pounds may have already been factored into the valuation of UK assets. Even in the event of a hard Brexit or no deal scenario, the “substantial drops in sterling could help to fire the FTSE 100 higher, as it did in June 2016, given how two-thirds of the index’s earnings hail from overseas,” according to Russ Mould, Investment Director in AJ Bell.


UK equity markets are now undervalued. 31 FTSE 100 firms are now trading on a price/earnings ratio (P/E) of 10 times or less for 2019, a lot lower than the rest of the world.


Besides the low P/E ratios, dividend yield seems high in UK. “The dividend yield means you are being paid to hold equities and wait for a recovery,” says Ben Yearsley, director of Shore Financial Planning. There are 36 firms within the FTSE 100 which offer a yield of more than 5.5%. This beats the 0.75% Bank of England base rate pretty handily and also outstrips the 1.25% yield available on the benchmark, 10-year UK government bond, or gilt.


The already cheap price and meaty dividend yield both contribute to the bullish view of UK stock market and explains why UK could be the top-performing market in 2019.






The above information does not constitute the provision of investment, legal or tax advice. Any views expressed reflect the current views of the authors, which do not necessarily correspond to the opinions of University of Waterloo Finance Association (“UWFA”). Opinions expressed may change without notice. Opinions expressed may differ from views set out in other documents, including research, published by UWFA. The above information is provided for informational purposes only and without any obligation, whether contractual or otherwise. No warranty or representation is made as to the correctness, completeness and accuracy of the information given or the assessments made.

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