Initial estimates of U.S. Q2 GDP, to be published next week, are expected to show further strong growth. U.S. earnings are also ahead of the pack. How long can this multi-speed world be sustained and how should you respond?
1. U.S. GDP growth could reach a rapid 4%+ in Q2. Elsewhere, trade conflict concerns are having an impact on macro and markets.
Q2 U.S. growth is widely expected to have reached 4% or possibly even higher. Meanwhile economic data out of the Eurozone remains mixed and recent Chinese monthly data has hinted at a potential slowdown. The threat of trade conflict escalation is casting a deepening shadow. President Trump presumably calculates that the U.S. economy is strong enough to ride through any trade-related shocks; China is presumably considering how it can loosen policy to cope with their implications. The Eurozone has neither the luxury of a particularly vibrant economy nor the ability to dramatically shift policy in the hope of shifting growth up a gear. The export-directed nature of many European firms also leaves them vulnerable to trade shocks (like their Japanese peers) and recent reversals in share prices reflect this. Earnings growth reflects this multi-speed world. With 10% of the S&P 500 market cap having reported, U.S. earnings growth is running at 21%. With the European Q2 earnings season about to kick-off in earnest, consensus expectations are for rather more modest growth for the Stoxx 600.
2. This multi-speed world could continue for some time, given Eurozone issues and policy constraints and China’s desire to deleverage.
In such a highly integrated world, how long can this divergence continue? For quite a long time, we think. The U.S. economy looks set for a period of sustained growth with Jerome Powell saying in his testimony to Congress this week that the U.S. economy likely has “several years of strong jobs and low inflation” still ahead. Longer-term issues around the budget deficit and debt are forgotten – for now. Europe lacks a policy means to kick-start growth, with the ECB very unlikely to loosen monetary policy and severe limits on the flexibility of fiscal policy. In China, the authorities are well aware of the need to reduce leverage in the economy and this means it will be tightening policy with one hand while loosening it with the other – the overall objective being a modest slowdown.
3. In the medium term, U.S. equities may prove more resilient, but markets may eventually reassess trade war concerns.
We have argued for some time that U.S. equities would be more resilient to trade concerns than their European or Japanese peers and this has proved to be the case. There may be some reassessment of expectations in the light of company guidance during this earnings season, but this preference is likely to remain. If the likelihood of a trade war is seen as receding, then the pricing of some assets (e.g. German bunds) could move closer to the levels normally associated with current GDP growth rates – although we could be in for several more months of volatility.
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