Both China and Europe are showing encouraging signs of improving growth, but it's the differences that investors may find most interesting.
Markets have been concerned about the near-term growth outlook in China, especially given heightened trade and tariff tensions. China has implemented massive stimulus policies already and we are beginning to see signs that this response is working. In 2018 and continuing in 2019, they’ve targeted liquidity in the market, issued special government bonds, given tax cuts to consumers and corporations, and reduced the VAT tax, which offset some of the impact from tariffs. All that has added up to 5.6% of GDP, which in absolute terms is the biggest stimulus China has ever done.
In addition, China put the brakes on the shadow banking system very dramatically over that same period, and that pushed money supply growth down from high double digits to basically zero. To offset that, China has reduced the reserve requirement ratio for banks several times, which allows them to lend more with existing capital. It’s a very powerful tool, but it can take some time for it to filter through the economy.
And finally, in the first three months of 2019 we have seen positive M1 money supply growth again into the low-single, mid-single digit region.
There is a lot of potential within China that is not necessarily directly linked to GDP growth.
It’s also important when talking about macroeconomic issues in China to consider the nuances in terms of what is growing, what is not growing and what is really impacted by current trade issues.
What we find some of the more traditional state-owned enterprise industries are much more impacted—and since they’re also more levered, those can be a little bit more worrisome. We also find that China is trying to grow very quickly in certain areas where they really haven’t had much expertise. For example, they’re trying to develop their own pharmaceutical industry.
Meanwhile the consumer has reoriented and is starting to spend in a meaningful way in areas where they haven’t traditionally spent, like in cosmetics and skincare. In addition, we’re seeing some new business models being developed around the cloud, e-commerce, etc.
So, there is a lot of potential within China that is not necessarily directly linked to GDP growth, but is quite encouraging and may be relatively insulated from some of the tariff squabbles.
Stimulus, European style
Stimulus continues to come from the European Central Bank (ECB). Originally, we expected the ECB to hike rates as was done in the U.S., but that hasn’t happened. Now, if you look at the short-term Euribor rate it’s telling you that no hike in short-term rates is expected until the end of 2020.
So barring a change in policy direction, there will be cheap money in Europe for the foreseeable future, at least a year and a half, perhaps even longer. That should be supportive for markets.
There will likely be another round of LTRO (Long-Term Refinancing Operations) financing for the banking sector as well. Most of the banks do not need that anymore; it was an instrument used after the financial crisis and most of the banks in the northern part of Europe and even in the middle are now recapitalized. However, there remain some problematic banks in the south, particularly in Greece and Italy, and in Spain to a lesser extent. They’ll probably take that money and invest it in their local bond market to create a positive spread, which would be extra income and positive for the overall capital. So overall that’s a good thing and that will happen over the next few years.
Stimulus has already led to some improvements in Europe. The consumer is pretty well off because the ECB initiated major quantitative easing in 2015. Unemployment rates are close to the lowest we have seen since before the financial crisis. We have seen wage growth in most parts of Europe, but particularly in the north; in Germany or Holland, there’s even a shortage of skilled labor.
So easy monetary policy has definitely had a positive impact and allowed financial restructuring to take place. Now it’s time for some changes at the fiscal level. And we are seeing a lot of encouraging signs there. Certainly when you look at things like earnings growth, what you see with the weaker currency is that for many of these large, European companies that have external businesses outside of Europe, earnings are quite flattered by the currency returns. Just the translation from strong dollar to weak euro has meant that earnings growth looks like it’s reaccelerating nicely in Europe and that’s kind of getting people’s attention.
In addition, low rates means it’s easier to finance acquisitions. Indeed, we are seeing a relatively strong M&A globally. Europe has been pretty active in that area. One other thing about a weaker euro: we know Europe has a pretty high component of its companies that have business in emerging markets. So, again, that’s flattered in terms of the earnings translation. So, overall, we’re feeling pretty good about what we see going on in Europe, in terms of eventual improvement.
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Gross Domestic Product (“GDP”) is an economic statistic which measures the market value of all final goods and services produced within a country in a given period of time.
M1 Money Supply is the money supply that includes physical currency and coin, demand deposits, travelers checks, other checkable deposits and negotiable order of withdrawal (NOW) accounts. M1 money supply growth refers to the increase or decrease in this measure of money.
A value added tax (VAT) is a type of consumption tax that is placed on a product whenever value is added at a stage of production and at final sale. The amount of value-added tax that the user pays is the cost of the product, less any of the costs of materials used in the product that have already been taxed.