T. Rowe Price: Risks of an economic downturn are limited

While the first half of 2019 saw ‘unusual behaviour’ in financial markets as the US yield curve inverted and equities made strong gains, there was not enough evidence to suggest a recession is forthcoming, according to T. Rowe Price’s Robert Sharps, Justin Thomson and Mark Vaselkiv.

“Despite the headwinds that are buffeting the global economy, we believe the risks of an economic downturn, whether in the US or globally, are limited,” the trio noted.

“In our view, at present there is little evidence of any imbalances that would suggest a recession is imminent.”

This outlook falls in line with the IMF’s “unsettled” weather forecast for the global economy earlier this year.

In April IMF chair Christine Lagarde warned that, whilst the global economy would undergo a slowdown in 2019 it would not fall into a fall blown recession.

She said: “A year ago, I said, ‘the sun is shining – fix the roof.’ Six months ago, I pointed to clouds of risk on the horizon. Today, the weather is increasingly ‘unsettled’”.

Whilst the T. Rowe strategists agree with the IMF’s earlier view that a recession is unlikely that does not mean that they have written off the risk of it altogether. Nor do they recommend investors overlook the impacts of the current global slowdown in relation to their future fund projections.

They said that there were still key factors involved, mainly China and the state of their own national economic slowdown, but also their ongoing US economic trade war as well as the Federal Reserve’s economic policy changing once again.

“A key variable in this story, however, is China. Growth in the world’s second-largest economy has already slowed, and further deceleration could have a negative impact at a global level,” they noted.

Chinese real GDP forecast – Total, Annual growth rate (per cent) 2009-2020

Source: OECD

The concern over the Chinese slowdown has not been eased by the government’s response back in 2018 with the implementation of credit easing and boosting spending.

But the main concern around China on a macro level is the burgeoning trade war with the US.

Although following the G20 summit in Japan this may now start trending positively as US president Donald Trump lifted the ban on US tech companies selling to China’s tech giant Huawei in what has been called a major concession on Trump’s part.

“At present investors are facing geopolitical risks from several angles,” the T.Rowe Price strategists said. “In Europe, for example, recent elections have shown that populism continues to be a powerful political force.”

But they added that it was the US-China trade war that was their biggest cause for concern.

“With trade disputes and populist politics creating potential downside risks, any flare-ups could be detrimental for financial markets,” explained Sharps, Thomson and Vaselkiv. “Any escalation of trade uncertainty could cause global sentiment to fall, dragging down hopes that corporate earnings growth will resume later in the year.”

Biggest tail risk

Source: BofA Merrill Lynch Global Fund Manager Survey

Indeed, concerns over a US-China trade war has been the top tail risk for international asset allocators for 14 of the past 16 months, according to the Bank of America Global Fund Manager Survey.

The reason that this has become such a major influence and consequentially had a damaging effect has been the unease it has cause investors.

“As threats of trade wars and tariff hikes have intensified, investors have become more uncertain about the future direction of economic policy,” they noted.

“Increased uncertainty can foreshadow a decline in economic growth and employment in the following months. Uncertainty reigned in late 2018 as concerns about trade wars dominated the agenda, and it was much the same in May as fears of an escalating trade war came to the fore once again.”

While US earnings growth has slipped after the impact of Trump’s tax cuts were stripped out, there could be room for further gains later on in the year if the global economic outlook improves, according to Sharps, Thomson and Vaselkiv.

“After making stellar gains in 2018, in part owing to US corporate tax cuts, US earnings growth decelerated in the first quarter of 2019,” they said.

Performance of sterling & euro in US dollar over 1yr

Source: FE Analytics

“All is not lost, however. The consensus earnings forecast is for a reacceleration later in the year, but achieving that result will require faster economic growth, particularly outside the US.”

However, that will be a challenge with most developed economies “growing below their potential” and earnings momentum negative in Europe and Japan. In addition, the strong US dollar is taking a toll on emerging markets, acting as a form of monetary tightening that has increased borrowing costs at a time when those economies are just starting to recover.

As such, the trio said that a strategic investment approach is necessary.

“We believe the second half of 2019 will see an environment of positive growth, low inflation, and market pressure on central banks to lower interest rates,” they said.

“This should support further market growth.”

They added: “In this climate, we believe investors are best served by keeping a disciplined, long-term perspective. Holding a globally diversified portfolio will help to smooth any bumps along the way and make the most of potential investment opportunities as they arise.”

But still they reminded investors that any major fluctuation from China for example could spiral growth, especially US corporate earnings.