It’s important to avoid the failed assumption that emerging
markets are underperforming and will continue to do poorly because China’s
economy is slowing. To be clear, the global economic slowdown is being driven
by developed markets and China, not emerging markets ex-China. It’s no surprise
China is acting like a developed market because it faces similar demographic
According to the IMF’s latest projections from January, world GDP growth will slow from 3.8% in 2018 to 3.5% in 2019. Advanced economies are leading the slowdown as their growth is expected to fall from 2.3% to 2%. America’s growth is expected to fall from 2.9% to 2.5%, but it’s still expected to be one of the fastest growing developed economies. On the other hand, emerging market and developing economies are expected to see 4.5% growth in 2019 which is only down 0.1% from the previous year. That growth is occurring even with the Chinese deceleration from 6.6% to 6.2%.
These projections are in tune with the chart below which shows the recently improving emerging markets’ leading activity index in relation to that of developed markets. The chart implies the dollar should start to underperform emerging market currencies.
To be clear, the IMF’s forecasts are in tune with the current results because its forecasts are usually a reflection of the present not the future. They provide a great summary of what is happening now, which is why we look at them. The recent January PMI readings continue this theme of developed market weakness, with America outperforming on a relative basis. The flash PMIs weren’t good as Japan’s was 50 which was a 29 month low, the Eurozone’s was 51.4 which was a 50 month low, Germany’s was 49.9 which was a 50 month low, France’s was 47.9, and America’s improved to 54.9. This weak German PMI is consistent with the decline in German 2019 GDP growth estimates from 2% in June 2018 to 1.2% now. Most of that decline has occurred since last fall.
Emerging Market Revisions Trounce Developed Market
Since technology drives America’s earnings growth and technology is the most internationally focused sector, the S&P 500 has seen its earnings estimates crater. The latest estimate is for just 3.42% earnings growth in Q1. Out of 115 firms that have reported earnings, only 56% have beaten sales estimates on 6.1% growth. If developed markets like Japan and Europe are showing slower growth than American firms and American firms are seeing cratering estimates, the chart above is no surprise. Emerging market revisions are now outperforming developed market revisions. The first chart in this article was bullish on emerging market currencies and this one is bullish on their equities.
China is the sore spot for emerging markets. The good news
is some of its economic reports recovered slightly in December. However, we can’t
ignore the big picture which is that 2018 GDP growth was 6.6% which was the
slowest growth rate in 28 years. China is planning on a major fiscal stimulus
in 2019. The hope is that America and China form a trade agreement that can
further promote growth. The big dispute is over intellectual property rights
and China’s large surplus with America.
Even though China’s growth is in a long term decline, it’s our duty to not gloss over some results that showed modest improvement in December. The chart below does an amazing job of summarizing all the recent data.
Industrial production and retail sales growth improved slightly. Industrial production growth was 5.7% which was up from 5.4% and beat estimates for 5.3%. Investment growth in December was stable as infrastructure and manufacturing were strong. Construction activity was very strong as growth accelerated to 14.6%.
Caterpillar & Nvidia Mention Weak China
Earlier in 2019 we heard Apple blame China for its negative guidance. This week we heard the same from Caterpillar and Nvidia. The chart below breaks down Caterpillar’s machine sales by region.
Asia Pacific led growth in 2016, but now has the lowest growth as it is only 3%. Specifically, the firm’s CEO stated,
“Sales in Asia/Pacific declined due to lower demand in China, partially offset by higher demand in a few other countries in the region.”
The firm expects flat construction growth in China, with positive growth in Asia-Pacific nations excluding China. In the recent quarter, North American construction growth was 17%. Construction sales were down 4% in Asia-Pacific. Tariffs cost Caterpillar $40 million in Q3. China only represents 5% to 10% of Caterpillar’s sales. China is more important to the global economy as over 30% of global growth will likely come from China in 2019.
Starbucks had similar results to Caterpillar in that Asia-Pacific ex-China outperformed China. China/Asia-Pacific had 3% same store sales growth with 1% transaction growth. China alone had a 2% decline in transactions and a 1% increase in sales. Even with China’s weakness, Starbucks increased its Chinese store count by 18%.
Nvidia faced issues in China as well. The firm lowered its Q4 revenue guidance from $2.7 billion to $2.2 billion. That is an 18.5% cut. Specifically, the firm stated there were “deteriorating macroeconomic conditions, particularly in China.” The firm’s CEO stated, “Q4 was an extraordinary, unusually turbulent, and disappointing quarter.” This isn’t good news for other tech firms with business in China.
The Fed Won’t Do Anything
The Fed’s January decision is relegated to a small portion of the end of an article, because there is a 100% chance it will maintain the Fed funds rate and the Fed doesn’t have much data to work with because of the government shutdown. A data dependent Fed without much data implies the Fed won’t change its course. The main change since the last Fed meeting is the significant stock market rally in January. Even with the strong equity performance in January, the chart below shows investors still expect the Fed to cut rates in 2020. The dovish Fed and lowered trade tensions with China have been named as the catalysts for the rally this year.
Even though we packed this article with a lot of data, it’s still only a brief overview of emerging markets, China, and developed markets. In summation, current data is suggesting that technology or any firms with Chinese exposure may underperform while emerging markets that aren’t China could outperform.
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