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Quarterly Liquidity Insights - Q3/2019

Previous quarterly commentaries suggested that global economic momentum would fall into a low around Q3 2019. Recent news is consistent with the scenario but money trends have yet to give a clear signal of economic recovery. A bottoming of momentum, however, may be sufficient to warrant increasing exposure to “cyclical” assets, including emerging market equities.

The expectation of a Q3 momentum low was based on monetary and cycle analysis. Global six-month real narrow money growth bottomed in late 2018 and leads economic momentum by nine months on average. The global stockbuilding cycle, meanwhile, last bottomed in Q1 2016 and has an average length of 3.5 years, suggesting another low in Q3 2019.

Incoming business survey data are consistent with the forecast. The global purchasing managers’ manufacturing new orders index recovered to a four-month high in September, while a survey-based indicator of the rate of change of G7 stockbuilding reached a seven-year low, consistent with the cycle being at or near a trough – see first chart.

Chart 1: G7 Stockbuilding & Business Survey Inventories Indicator (YOY Changes)

Chart showing G7 Stockbuilding & Business Survey Inventories Indicator

Economic momentum may be bottoming but money trends argue against a significant near-term recovery. Global six-month real narrow money growth remained below 2% through August compared with a post-GFC average of 3.4% (i.e. over 2010-17). Preliminary data suggest a pick-up in September but this is unlikely to be reflected in economic activity until mid 2020, based on a historical average nine month lead – second chart.

Chart 2: G7 + E7 Industrial Output & Real Money (% 6M)

Chart showing G7 + E7 Industrial Output & Real Money

From a cycles perspective, a prospective turnaround in the stockbuilding cycle may be offset by further weakness in the business investment cycle, which may not trough until early 2020 – the last bottom was in Q2 2009 and the cycle can stretch out to 11 years.

The baseline scenario is that economic momentum will remain weak into Q1 2020 before picking up more convincingly around mid-year. The latter forecast requires confirmation from a further rise in real narrow money growth. Cycle analysis suggests that the global economy will grow solidly in H2 2020: the business investment cycle as well as the stockbuilding cycle should by then be in a recovery phase, while the upswing in the longer-term housing cycle is likely to have regained momentum in response to falling mortgage rates in 2019.

The above scenario suggests that an increase in EM exposure will soon be warranted. EM performance relative to developed market equities correlates with the global stockbuilding cycle, which drives commodity prices and – as discussed – may already have hit bottom.

The case for raising EM exposure would be strengthened by a pick-up in Chinese real narrow money growth – third chart. A recovery in nominal money growth appeared to be under way in early 2019 but stalled after the failure of Baoshang Bank in May, which disrupted interbank funding and credit supply to private firms. A food-driven inflation spike has dragged down real growth more recently, though is likely to reverse in late 2019.

Chart 3: Real Narrow Money (% 6M)

Chart showing Real Narrow Money

Money trends are mixed in other emerging economies. Rate cuts have contributed to a pick-up recently in Russia and Mexico – third and fourth charts. By contrast, Indian six-month money growth fell sharply during Q3, although this appears to reflect pay-back for a temporary surge ahead of the April-May election, suggesting a rebound in late 2019. The recent corporate tax cut package, amounting to 0.7% of GDP, was a positive surprise.

Chart 4: Real Narrow Money (% 6M)

Chart showing more Real Narrow Money

Brazil remains a negative outlier – real narrow money contracted in the six months to September, suggesting a need for further rate cuts. By contrast, money growth is booming in Chile, where the economy and stock market could also benefit from a stronger copper price as the global stockbuilding cycle moves into an upswing. Numbers have also picked up in Colombia and Peru.

The baseline scenario of a global economic recovery unfolding during 2020 would argue for increasing exposure to “cyclical” markets at the expense of “liquidity-sensitive” markets that could suffer relatively as Fed easing comes to an end and Treasury yields rebound. This favours Korea and Taiwan, which are sensitive to global activity but also enjoy a positive monetary backdrop currently. Korean relative performance has tracked the fall in the global manufacturing PMI, which may be at or close to bottom – fifth chart.

Chart 5: MSCI Korea Relative & Global PMI New Orders

Chart showing MSCI Korea Relative & Global PMI New Orders

Cyclical markets in emerging Europe include Poland and Greece, where monetary trends are relatively strong. Indonesia is the most cyclical market in South East Asia; most regional markets are liquidity-sensitive, although solid money growth – particularly in Thailand and the Philippines – may offer support in the event of a rise in Treasury yields.

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