Is the world ‘edging away’ from recession?

In an update for clients, she wrote: “The global economy ended the year showing signs of resiliency, exhibiting a second month of modest expansion, according to the latest [S&P global purchasing managers’ indices]. The Global composite (services and manufacturing) PMI climbed 0.5 points to 51 in December.

“It was the second month of expansion, following stagnation in October, and the highest reading since July. Moreover, the recent months’ acceleration triggered a buy signal in our equity indicator,” Grindal continued.

“Leading indicators, such as overall new orders and the future output index, rose to their highest levels in six months, indicating continued growth in the near term. The composite PMI moved further away from its global recession threshold of 47.8, historically associated with recession.”

Grindal added that the pace of growth in PMIs remains below long-term averages, implying growth will similarly be below long-term trend rates. Her view is that whatever growth there is will be unevenly distributed, with the services components of economies continuing to perform well, while manufacturing performs less well. 

Happy-go-lucky?

Perhaps linked to those sectoral trends, she is “concerned” about the prospects for the continental European economies, which tend to have large manufacturing bases, but also noted that the services sectors there are also declining.

GlobalData TS Lombard director of global macro Konstantinos Venetis says that while the macroeconomic data gives credence to a view of “cautious optimism”, he believes that some of the upward momentum associated with the prices of risk assets lately implies an “all clear” for the global economy, rather than a slow shift upwards.

Venetis argues that the US economy will continue to drive growth: “This remains a largely asynchronous economic cycle. Europe is stagnating and China is on course for another year of weak growth, which still leaves the US pulling the growth cart on its own.”

He says that if there is to be a sharp change in the economic narrative, it is more likely to be a case of the US economy declining in performance terms and beginning to resemble Europe, than the other way around. 

Europe is stagnating and China is on course for another year of weak growth, which still leaves the US pulling the growth cart on its ownKonstantinos Venetis, GlobalData TS Lombard

Kingswood Group chief economist Rupert Thompson says he believes the “macro environment is much improved”. He is cautious on the outlook for inflation, and in particular around the recent rally in equity prices, which he feels has been driven by the view that inflation will be lower. 

“It remains far from clear how easy it will be to reduce inflation all the way down to the 2 per cent targeted by central banks. Longer-term sources of inflation pressure include deglobalisation, decarbonisation and ageing populations,” he says.

“If growth were to remain firm, inflation could quite conceivably rear its ugly head again down the road. When push comes to shove, the authorities may well tolerate inflation remaining closer to 3 per cent, if a return to 2 per cent required a recession.”

Thompson believes that the more positive economic outlook is currently “priced in”. He says: “Global equity valuations are back a bit above their long-term average, while bonds are now pricing in rates falling considerably faster than the central banks are suggesting. There is still reason for some caution.

“As we have noted before, the momentous forecasting misses by almost all and sundry in recent years mean one should keep a fairly open mind about what lies ahead. The structural changes under way in the global economy mean economic forecasting is even more difficult than ever.”

Venetis says he is encouraged by how the equity market rally has evolved in response to the data. “What is encouraging is that the breadth of US equity gains has improved during this rally: small-caps have outperformed and large-cap, equal-weighted indices have outpaced their market cap-weighted counterparts, which are dominated by the [large technology stocks],” he says.

“In addition, while the upturn in global profits [MSCI World index] since spring 2023 remains predominantly a US story, it looks as if the rest of the world is starting to play catch-up. After staying flat through the [second half of] 2023, non-US forward earnings expectations have picked up in the last couple of months – notably in the euro area and [emerging markets] ex China – adding to sustained strength in the US and Japan.”

Where’s the opportunity?

Abrdn senior investment manager Jason Day is another who believes the next leg of growth in the US market could be away from the large caps.

He regards large caps as being there for defensive reasons, in case of a downturn, while regarding small and mid-cap companies as being attractive both in terms of being able to capture any uptick in economic growth, but also on valuation grounds, as he notes that the smaller companies currently trade at a wider discount relative to the larger firms than has been the case for the past 30 years. 

It remains far from clear how easy it will be to reduce inflation all the way down to the 2 per cent targeted by central banksRupert Thompson, Kingswood Group

Quilter Investors portfolio manager Stuart Clark says that rather than being in a “Goldilocks scenario” of inflation falling without a recession occurring, there is an element of pain being postponed, while good economic news may prove to be bad news for investors. 

In terms of what this may mean for investors, Clark says that following a very strong performance for most assets at the end of 2023, markets have been “nervy” in 2024.

He feels this is a consequence of the view that the persistently stronger economic news may mean interest rates are not cut with either the frequency or velocity that investors had priced in, which would have a materially negative impact on the performance of some asset classes — since, in his view, those asset classes are already pricing in rate cuts that may not happen. 

This bout of optimism is also concerning Close Brothers Asset Management chief investment officer Robert Alster. His view is that while the tone of US central bank communication has altered in a way that indicates a positive outcome for risk assets, he is wary that the market may be pricing in too many rate cuts. 

But he does note that some data in the UK points to a “modest recovery in confidence”, while in the eurozone he expects inflationary pressures to ease from here. 

David Thorpe is investment editor at FT Adviser