Scott Barlow, Globe Investor’s in-house market strategist, writes exclusively for our subscribers at Inside the Market.
Downward revisions to expectations for global economic growth continue and this is a bad sign for Canadian investors, even those entirely concentrated in domestic stocks.
The Organization for Economic Co-operation and Development on Wednesday downgraded its forecasts for worldwide gross domestic product expansion to 3.3 per cent (from 3.5 per cent) for 2019 and to 3.4 per cent (from 3.5 per cent) for 2020. Ominously, the OECD added “downside risks continue to build” in a suggestion that this is not the last cut to forecast growth.
The S&P/TSX Composite Index, with its 29-per-cent weighting to energy and materials, is extremely sensitive to changes in international growth.
The Bank of Canada highlighted the importance of the global economy to domestic business activity in Wednesday’s statement on monetary policy. As part of its reasoning for not hiking rates, the bank noted, “Recent data suggest that the slowdown in the global economy has been more pronounced and widespread than the Bank had forecast in its January Monetary Policy Report (MPR). … Trade tensions and uncertainty are weighing heavily on confidence and economic activity."
Statistically, the clearest relationship between domestic equities and the global economy is through manufacturing activity, as the first accompanying chart underscores.
Domestic equities and global
manufacturing activity
Year-over-year percentage change
S&P/TSX
Composite Index
(left scale)
JPM Global
Manufacturing PMI
(right scale)
30%
8%
25
6
20
4
15
2
10
5
0
0
-2
-5
-4
-10
-6
-15
-20
-8
2014
2015
2016
2017
2018
2019
CARRIE COCKBURN/THE GLOBE AND MAIL,
SOURCES: BLOOMBERG; SCOTT BARLOW
Domestic equities and global
manufacturing activity
Year-over-year percentage change
S&P/TSX Composite Index
(left scale)
JPM Global Manufacturing PMI
(right scale)
30%
8%
25
6
20
4
15
2
10
5
0
0
-2
-5
-4
-10
-6
-15
-20
-8
2014
2015
2016
2017
2018
2019
CARRIE COCKBURN/THE GLOBE AND MAIL,
SOURCES: BLOOMBERG; SCOTT BARLOW
Domestic equities and global manufacturing activity
Year-over-year percentage change
S&P/TSX Composite Index (left scale)
JPM Global Manufacturing PMI (right scale)
30%
8%
25
6
20
4
15
2
10
5
0
0
-2
-5
-4
-10
-6
-15
-20
-8
2014
2015
2016
2017
2018
2019
CARRIE COCKBURN/THE GLOBE AND MAIL, SOURCES: BLOOMBERG; SCOTT BARLOW
The purple line is the year-over-year change in the domestic equity benchmark and the light-blue line is the annual change in the JPMorgan Global Manufacturing Purchasing Managers’ Index. The latter combines national surveys of manufacturing executives regarding activity, hiring and orders for new goods.
The correlation between global manufacturing activity and the TSX has been reasonably high in the past five years. In 2019, it appears that the domestic equity rally is not justified by the global growth rate, implying higher risks of a market pullback. However, it is also important to note that the PMI data are backward looking – indicating what has already happened – whereas equity markets are, at least in part, a forecast for future profit growth.
The second chart focuses on the connection between domestic equity prices and Asian economies. I recognize that South Korean markets are not top of mind for Canadian investors, but market strategists such as Richard Bernstein of RB Advisors have historically watched South Korea – with its position as central regional trade hub for both industrials and technology – as a leading indicator for global growth.
Domestic equity prices
and Asian economies
Year-over-year percentage change
S&P/TSX Composite Index
South Korea new manfacturing orders
2
5
%
2
0
1
5
1
0
5
0
-
5
-
1
0
-
1
5
-
2
0
2014
2015
2016
2017
2018
‘19
CARRIE COCKBURN/THE GLOBE AND MAIL,
SOURCES: BLOOMBERG; SCOTT BARLOW
Domestic equity prices and Asian economies
Year-over-year percentage change
S&P/TSX Composite Index
South Korea new manfacturing orders
2
5
%
2
0
1
5
1
0
5
0
-
5
-
1
0
-
1
5
-
2
0
2014
2015
2016
2017
2018
‘19
CARRIE COCKBURN/THE GLOBE AND MAIL,
SOURCES: BLOOMBERG; SCOTT BARLOW
Domestic equity prices and Asian economies
Year-over-year percentage change
South Korea new manfacturing orders
S&P/TSX Composite Index
2
5
%
2
0
1
5
1
0
5
0
-
5
-
1
0
-
1
5
-
2
0
2019
2014
2015
2016
2017
2018
CARRIE COCKBURN/THE GLOBE AND MAIL, SOURCES: BLOOMBERG; SCOTT BARLOW
It’s also notable that South Korean data are viewed as far more reliable than China’s official statistics, and can provide a more accurate view of regional activity. For Canadian investors, this insight into Asian growth is of central importance because of China’s dominance in global commodity demand.
According to statistics from global investment firm KKR & Co., China now consumes 51 per cent of global coal (up from 31.5 per cent in 1995), 13 per cent of oil (4.7 per cent in 1995) and 44 per cent of global steel production (12.7 per cent in 1995). Canadian firms export almost exclusively to the United States, but it’s China’s fast-growing demand that determines the price for global commodities.
The weakening global economy is seemingly negative for the S&P/TSX Composite as a whole, but a look at current trends in the bond market strongly suggests it might be positive for popular dividend-paying market sectors.
To the extent the domestic economy imports weakness from abroad, this puts downward pressure on bond yields and interest rates. On Wednesday, Ian Pollick, an interest-rate strategist at Canadian Imperial Bank of Commerce, wrote that speculative (and usually algorithmically driven) commodity trading adviser funds (CTAs) are currently betting heavily on lower long-term Canadian bond yields. “We find that trend-following CTAs are extremely long 10-year [government bond] futures,” he wrote.
Lower risk-free bond yields make higher-yielding equity instruments such as real estate investment trusts and utilities more attractive by comparison, and they should benefit as yields fall.
Scott Barlow