We believe the destination is in sight. Bringing global inflation back to sustainable levels has been a long journey, but now we are nearing the end of this flight. Most central banks have inflation under control, and we are finally starting to see interest rates coming down. This is good news for businesses, consumers and as a result, economies.
The question is, as we make our approach, are we in for a soft or a hard landing? The risk for a hard landing, especially for the United States (US), is easing, as the US Federal Reserve (Fed) is now proactively cutting rates, which supports the case for a soft landing. Its first rate cut was 50 basis points, which showed that the Fed is concerned about the impact of tight monetary policy on the US economy – and consumers specifically. Given the strength of the US labour market, we may see an even better result, with the US avoiding recession altogether.
A theme that emerged this year has been the divergence in economic growth of the major developed markets. While the US has continued to grow steadily, Europe, the United Kingdom (UK) and Japan entered into recessionary territory, with barely any growth worth mentioning. These countries were first off the block to start normalising policy and cutting rates – weeks before the US – in an attempt to get their economies going.
Drivers of economic growth
Before we unpack what is happening across these regions, we need to understand what drives economic growth. There are four factors that impact the growth of an economy:
- Consumer spending.
- Fixed asset investment through public and private investment.
- Government spending and how it manages the economy.
- Net trade, which is imports minus exports.
Each economy will be driven by a combination of these factors to a greater or lesser degree, depending on which one we look at. For example, the US and South African economies are consumer-driven, meaning that consumer spending makes the biggest contribution to economic growth – 70% and 66%, respectively. An economy like China, on the other hand, is supported by fixed asset investment which makes up about 45% of that economy, and although the Chinese government is looking for the consumer to play a bigger role, Chinese consumer spending only contributes around 40% to China’s growth. Germany, Japan and China, to a certain extent, are net exporters, so the global trade wars and the slowdown in globalisation provide strong headwinds to these economies.
Following the pandemic, global trade has been moving sideways, with an increase in activity of just 2%. This is not an indication of a world that is growing extremely fast. While trade between the world’s two largest economies, the US and China, has been underwater for the last two-and-a-half years, trade, the world over, is down. Trade growth since the early 2000s, when China joined the World Trade Organisation, sat at around 8% per annum for almost a decade. It started to slow in the late 2000s, as globalisation began to mature, but it is really since the pandemic that we have seen a step-change in global trade, with the figure falling to 2.5% per annum. This is one reason we are seeing net exporters facing headwinds.
When we realise that economies are not equal in terms of what drives them, we can then better understand the current divergence in global economic growth. Indeed, the numbers reflect this. US personal consumption expenditure (PCE) is up 12% since COVID, while Japan, the UK and Germany are all still sitting at COVID levels, meaning their consumer consumption has hardly picked up. In addition, unlike the US, these economies have also been impacted by post-COVID trends like supply chain disruptions, the global economic slowdown, deglobalisation and increased tariffs
A robust US walking a fine line
The US consumer will be buoyed by easing monetary policy because the wealth effect of cutting interest rates can be significant. The US has not seen a major decline in property prices or in the equity market, which is indicative that US wealth is solid. In fact, US net wealth is currently at an all-time high. US consumers are, therefore, feeling good from this perspective, which will continue to underpin their spending.
Although US consumers have maintained their standards of living and navigated the high interest rates, they have started to deplete their savings. A lack of savings will put pressure on US consumer confidence in the future as concerns grow around job security and how they will fund higher interest rates should they not have a savings buffer.
Job security is increasingly becoming a threat for the US consumer as the country’s labour market is under pressure. When unemployment numbers start to creep up, they can quickly move to much higher levels, which then very often signals a recession is on the cards. Currently, the unemployment numbers are suggesting a soft landing, as they are not at a point where they would be if we were to see a full-blown recession.
Despite US consumers being robust, they are facing headwinds. We are seeing an increase in auto loans and credit card delinquencies, which are now in line with levels last seen during the 2008 financial crisis. US consumers are increasingly concerned about falling behind on their bills, and their level of concern is at its highest point since before the start of the pandemic in 2020. Fortunately, the Fed has started to cut rates and kicked off with a 50-basis point cut in September. However, they still have a long way to go to get rates off their record-high levels. Interest on credit cards for the US consumer can be in excess of 20%, which means that interest repayments as a percentage of income have doubled over the last few years and make up a significant chunk of indebted consumers’ cash flow.
A positive result of the current situation is that following the pandemic, households had less debt than they did in 2008. This means that the financial squeeze they are currently feeling is not as severe as it was during the financial crisis, which will make them feel more secure despite the higher interest rates.
Given the current consumer sentiment, we believe that the US will slow down, but to capacity growth, which is around 2% per annum. And given the Fed’s easing of its monetary policy, the US consumer may get through this patch without any significant damage.
The best of the world
Consumers in the rest of the developed world cannot support their economies like the US consumer does. This is for a number of reasons. The first is that most global developed market economies are not consumer driven. Also, those consumers had less support from their governments during the COVID-19 pandemic, which means they did not have the same level of savings that the US consumers did. This lack of savings saw them unable to weather the cost-of-living crisis as well as US consumers did. To alleviate some of the pressure on consumers, and given that inflation was under control, the European Central Bank (ECB) and the Bank of England, for example, started cutting rates before the US.
Adding to their economic woes, the European and Japanese economies are much more exposed to global trade. As global economies have started to slow, and with China facing its own economic challenges, which include trade wars, internal structural challenges, deglobalisation and supply-chain diversification, many of these economies are being impacted.
European union in a rut
Over the last 12 months, European Union (EU) growth has barely been positive, but the ECB’s cutting of rates has resulted in a rebound in sentiment. Having said that, in the major growth engines of the EU economy, France and Germany, confidence is down sharply, at its lowest level in three years. This points to a further slowdown in those economies and in the EU economy as a whole.
Looking at the EU consumer, there has been a slight recovery in consumer spending, and retail sales have started to pick up. With interest rates falling and unemployment remaining steady, the EU consumer could start contributing more in terms of economic recovery.
On the other hand, a number of EU economies are major exporters and important manufacturers. With the global economy under pressure, they are struggling. If we look at Italy, their manufacturing sector has not recovered since the pandemic, while France and Germany are both still about 10% down in their post-pandemic manufacturing activity.
The German automotive manufacturing industry, for example, has been flatlining since 2020 and has only just returned to pre-COVID levels. The four-year lag has had a major impact on the German economy, which is built around the automotive sector. This then has had a knock-on effect on the EU economy as a whole. There are a number of reasons for this poor performance. The sector is facing challenges in terms of production costs, energy costs given the war in Ukraine, and then, also competition from around the world, especially as they were late off the starting blocks with the production of electric vehicles (EVs).
In the global EV market, China is currently producing around 70% of the world’s EVs, the US produces about 10%, and Europe the rest. As the EU is behind China on the curve, they have been hit hard, especially since Europe imports a large number of EVs from China, because the EU has strict emissions targets and wants to start moving away from combustion engines. This dynamic is adding to Europe’s slow-down mix.
In an effort to protect the German automotive industry and to help with its EV competitiveness, the EU has started to implement tariffs on Chinese EVs. This move further highlights how the global slowdown has impacted an exporting country like Germany.
China struggling to reach 5% growth
China is a very important player in the global economy, and its struggles are the world’s struggles. Following the fallout from the pandemic, China is battling to get its economy back to its 5% growth target, with 2024 seeing China battle its own particular economic challenges. These include debt issues, an ageing population, deflation as opposed to inflation, a real-estate bubble and low consumer confidence.
Although the Chinese government has been slow in providing support for its economy, in September, it did announce its “Three Arrow” stimulation plan. The plan includes:
Easing of monetary policy, where key interest rates are being reduced by about 20 basis points.
Stimulating the property market by making the purchase of second properties more affordable by reducing the required deposit from 25% to 15%, making it easier for people to get into the space. In addition, mortgage rates have been reduced by 50 basis points.
Targeted stimulus for equity markets of around 1% of gross domestic product (GDP). This support will allow companies in some sectors to buy back their stock and for financial services companies – like insurance and asset management companies – to buy a share in the stock market. The announcement of this stimulus plan had a dramatic impact on Chinese equity markets, which were up 20% following the announcement.
So, the big question, with regards to the Chinese economy, is whether the stimulus package is, in fact, the bazooka the economy needs to achieve its elusive 5%-growth target. Citadel’s view at the moment is that while it’s a step in the right direction, it is not a silver bullet. It will come down to efficient implementation, and only then will we see in which direction Chinese growth will go. But as noted above, the stimulus package is aimed at broadly supporting the Chinese economy. And the Chinese government has promised further support if it is needed.
The Chinese government also wants the Chinese consumer to play a bigger role in the country’s growth. Currently, consumer activity only accounts for 40% of the economy and has not contributed significantly to the country’s growth over the last three years; in fact, it has been the opposite. Consumer consumption has dropped sharply, and as a result, fixed capital formation, which is an investment into the economy, has had to pick up to make up for this loss.
Adding to China’s woes is that Chinese consumer sentiment is weak, and consumers are unlikely to start spending. Chinese consumer dynamics are very different from those of the US consumer. The Chinese still have excess savings and low debt, but despite this, they are not spending. Retail sales are much lower than where they should be after the pandemic. This indicates that they are still extremely concerned.
As mentioned, however, Chinese fixed investment is picking up to counter the lack of consumer spending, and manufacturing has grown and is up more than 30% since the pandemic. Yet, property, the Chinese economy’s biggest concern, is suffering from an over-supply and has potential implications to destabilise growth, which is already declining rapidly. So, while manufacturing is up 30%, the property sector is down around 20%. This means that the government needs to navigate how best to stimulate and thus drive the economy forward.
While we do not believe the current stimulus package will get the economy going, we do believe it will stop the economy from slowing down further in the near term. Then, with the correct implementation, we could see China’s growth pick up to an average of 4.5% over the next three years.
Inflation and interest rates
The growth of the global economy is currently desynchronised, with the US achieving 3% in the second quarter and countries like the UK, EU nations, and Japan all barely seeing positive numbers. However, all the regions have embarked on their rate-cutting cycles at roughly the same time. This should ideally be good for the global economy going forward, and while there is lower capacity growth, there is more liquidity coming into the system, which will alleviate the risk of a hard landing, as the cost of capital is being reduced.
Central banks, however, need to be careful because while most major economies appear to have inflation under control, it doesn’t mean that inflation can’t rear its head again. There have been a few headwinds that have had inflationary effects on economies. One of these is the oil price, and if the Middle East conflict broadens, this could see oil prices soar, which would impact inflation across the globe.
Therefore, any policy mistakes on the part of central banks could see inflation come back over the next couple of quarters. This will mean central banks will have to reverse their policies, but this time around, there will be greater potential for causing damage. Having said that, if things remain stable, then the rate-cutting cycle should continue for the next 12 months, going into 2025.
Global growth to slow…permanently
Looking at global growth over the next two to three years, we believe that the US will slow down in an orderly fashion, getting closer to trend growth of 2%. The rest of the developed markets are still battling to find their feet. If the US gets away with a soft landing and China gets its growth engine going again, the rest of the developed markets should be able to pick up.
Over the last decade, global growth was around 3%; going forward, we believe that this number will find a footing at around 2% to 2.5%. Most notable with regard to future economic growth is that the US and China will contribute less to this growth, and emerging markets, especially India, will start taking over in terms of their contributions.
South Africa
Turning our attention to South Africa, at the end of September, the Government of National Unity (GNU) achieved an important milestone: its first 100 days in office. The verdict, however, is still out on whether it will be a success, but a recent survey showed that the majority of South Africans are happy with its performance to date.
GPU boosts sentiment
South Africa has outperformed its peers this year when we look at the various asset classes. Local equities, bond markets and the rand rank in the top three of emerging market economies. This is based on the sentiment that the GNU is moving the country in the right direction. Improved sentiment has resulted in solid returns in these asset classes but has also reduced South Africa’s funding costs as the yields on South African government bonds have fallen.
This quarter, South Africa also has its Medium-Term Budget Policy Statement (MTBPS) at the end of October. While the sentiment around South Africa is based on a “hope” of things getting better, the growth of the country will ultimately depend on the actual numbers. The MTBPS will likely be a reality check, as it will highlight how much hard work is ahead for the GNU. Should the new government not deliver, South Africa will be stuck in an ongoing rut of poor economic growth.
South Africa’s growth is now marginally higher than it was in 2020, just before the pandemic, but the reality is that over the last 15 years, South Africa’s growth momentum slowed rapidly. This was due to the administration at the time, structural issues and a lack of confidence in the country. As a result, South Africa has underperformed its peers, and the World Bank recently released a report that noted our lack of competitiveness in terms of the global economy and exports.
It identified that the low-hanging fruits that would be easy to remedy were:
- Policy implementation.
- Fixing the issues with our ports and logistics issues to assist with the exportation of our raw materials.
- Improving South Africa’s beneficiation abilities so we are not simply exporting but also adding value to our raw materials.
- Reforming the country’s trade policy.
Doing this would add value to the country’s overall competitiveness.
Essentially, the report says that while we are focused on fixing our structural issues, we also need to look at our competitiveness as an economy. When you examine South Africa’s share of world exports as a percentage of global trade, South Africa’s exports have fallen from a peak of 0.7% to around 0.4%, which is a big share of lost global exports for the country. There has been almost zero growth in South Africa’s imports or exports in the past year, which reflects the issues around South Africa’s competitiveness, as highlighted by the World Bank.
The issue with our ports, while hampering the country’s ability to move goods in and out of the country, is also seeing South Africa miss other opportunities. The geopolitical challenges around the Red Sea shipping route have resulted in a large volume of ships circumnavigating the southern tip of Africa, and due to South Africa’s port crisis, the country is unable to accommodate them. This leaves countries like Namibia, Mauritius and Madagascar picking up this business.
There has, however, been some movement to address these issues. The third quarter saw the signing of the Economic Regulation of Transportation Act, which is a step in the right direction. The new act provides regulations to allow the private sector to start participating in the logistics side of the economy, including ports. This could help resolve many of the issues that are currently hampering progress, possibly having the same impact the solar boom had on the electricity sector. Indeed, two years ago, the country was experiencing unprecedented loadshedding, and today there is none.
While the end of loadshedding was partly a function of the solar boom, which took a lot of the pressure off the Eskom load, it was also because Eskom addressed some of its infrastructural issues. As a result, we have seen very strong numbers in terms of electricity production in South Africa over the past 12 months. This is in contrast to the negative production of power seen over the previous two years. Eskom is producing 7% more electricity now than it did a year ago, indicating that one of South Africa’s structural issues is being resolved and highlighting the importance of correcting structural issues to the economy and sentiment. It may also have the benefit of attracting more fixed investment into the industry. We are hoping to see a similar development in South Africa’s logistics and ports.
The GNU has also bolstered consumer sentiment in its first 100 days, which is at its highest level since 2010. This is being reflected in retail sales, which compared to a year ago, have turned positive and are up nearly 3% year-on-year. While the South African consumer is still under pressure with high interest rates and record-high unemployment rates, the rebound in confidence has boosted consumer spending. However, unemployment is not helping South Africa’s growth as a consumer-based economy.
Local manufacturing also saw a rebound with the formation of the GNU, with the Purchasing Managers’ Index (PMI) climbing above 50, being bolstered by more positive business expectations.
It is early days, but we do think this positive sentiment will continue. If it does, we can assume better growth numbers as well, where South Africa moves closer to 2.5% growth over the next three years. But it is all dependent on the GNU remaining “married” and being able to effectively implement these measures.
Citadel Asset Management cautiously optimistic
At Citadel, while we are cautiously optimistic, we still anticipate slower global growth with a number of challenges still ahead. We do, however, believe things are better now than they were a year ago when a global recession was still very much debated as global economies continued to battle inflation.
Now we are more certain that inflation is under control, and it could trigger the 10-minutes-to-landing announcement that interest rates will start declining. This would mean that the world returns to a more normal economic cycle, where we are deflating the economy. If all goes well, we could engineer a soft landing, which will then result in capacity growth for the world economy over the next three or four years.
While there are some headwinds for some asset classes, there are definitely tailwinds for others, creating opportunities for us to include them in our client portfolios.
Harold Strydom will give you a more in-depth look at Citadel Asset Management’s asset class outlook.
