At a recent charity event I attended there was a fortune teller roaming around enticing guests to her stand, where she had a crystal ball, tarot cards and other paraphernalia. This had me thinking – if only investors could predict what is in store for the global economy next year.
Alas, I have no crystal ball at my disposal, but there is a multitude of macro indicators that can help us understand what to watch out for.
The eurozone economy is in good health, fuelled by a broad-based recovery in the region. Expectations of economic activity picked up in November across Germany, France, Italy and Spain, as measured by the Purchasing Managers’ Index (PMI) surveys. Historically, the eurozone Composite PMI has been a good leading indicator of GDP growth, which currently stands at 2.5 per cent year on year. The Composite PMI increased at the November to 57.5 – a level that has historically been consistent with GDP growth staying above 2 per cent.
With the unemployment rate in the region falling consistently, at an approximate pace of 1 per cent a year, since July 2015, labour dynamics in the eurozone continue to improve. As more Europeans find themselves in work, consumer confidence has been driven upwards, recently reaching its highest level since 2001.
If unemployment pursues this downward trend, we could see it return to pre-financial crisis levels in the next 18 months. This would push consumer confidence higher and boost consumption, providing support for the region to grow further from here.
Certainly, the European consumer is already feeling upbeat, as shown by the strong pick-up in retail sales to 3.7 per cent year on year (y/y) in the November reading. Conversely, consumers in the UK have been experiencing a squeeze on real incomes, as inflation remains higher than wage growth.
This has weighed on spending in the UK, leading retail sales to soften by 1.2 per cent (y/y) – a significant drop from their 7.3 per cent peak in 2016. Since consumption is such a key driver of GDP in both economies, this leads us to have a more constructive view on European growth compared with the UK, where the outlook appears to be more uncertain. Healthy, synchronised growth in Europe should remain supportive of corporate earnings, and thus European equities, over the coming months.
On the other side of the pond, robust US growth is being supported by an improving labour market and rising consumer confidence. The recent Conference Board consumer confidence survey shows further signs of tightness in the labour market, with an increase in the gap between those who think jobs are plentiful and those who think they are hard to get.
Historically, this has led to upward pressure on wage growth. If wage growth accelerates, this could further boost consumer confidence, which has now reached its highest level since 2000.
However, as wage growth picks up, the Federal Reserve may need to increase the Fed funds rate faster than the market expects. Higher interest rates could also pose problems for US companies who would have higher interest expense.