Economic growth slowed down in the second half of 2018. This rather harmless event caused major disappointment, as the financial community appears to want the economy to gain further momentum every month.

This has remained very much the case in the first few months of 2019: investors are hoping that growth will stabilise, before re-accelerating this summer in most of the world’s regions. Naturally, this scenario has more to do with wishful thinking than to thorough analysis, but then again, this is often the case in our line of work!

The economy can be analysed based on long and short cycles and the unemployment rate is a useful indicator for long cycles. If we look at the unemployment rate in OECD countries over the past forty years, what does it tell us?


It shows that the current cycle is remarkable in many ways, particularly in terms of its strength and its length. We have very recently spotted a slight contrary movement…but should this be interpreted as a trend reversal? After climbing for a very long time, the economies of the OECD – in terms of cumulated growth (output gap) may now have reached their peaks.

It therefore seems strange to us that the consensus is considering a re-acceleration of growth this spring… when the economy has only just begun to decelerate! The cycle has lasted much longer than earlier cycles for clear and well-known reasons: exceptional monetary conditions (negative real interest rates in most developed countries) and unprecedented support from budgetary policies (global public debt to GDP ratio at a historic high).

The global economy has performed exceptionally well since the financial crisis and it would be very wrong to assume that these growth levels are the norm. Many economists are discussing the idea of potential growth; butwe do not believe in this concept as they describe it, where the gap between growth and potential growth implies economic imbalances, and notably price instability. This is yet another “Canada Dry theory”: it tastes like the real thing but in reality, nothing proves that it is.

Nevertheless, we believe in the cycle and in the fact that in some circumstances, the economy can reach a “natural” pace of growth (however the relationship with prices is inexistent, as unfounded). The double-edged monetary and budgetary shock of recent years enabled G20 countries to boost their growth levels by around 3%, as shown in the following graph:



The key point here is that the causal link between the variables has changed. Previously, strong growth - of around 3% - would lead to the normalisation of monetary policy and a decline of the budget deficit. In this cycle, the relationship is broken. With the exception of the United States (and to a much lesser degree, Canada), central banks have not tightened their monetary conditions. As for the budget deficit, levels started to rise again from 2014/2015 after several G20 countries chose to reverse their fiscal policy (Brazil, China and Russia), followed by the United States in 2016/2017.

Monetary and budgetary policies, key automatic stabilisers, therefore turned into exogeneous variables to support markets in the post-crisis periods. In light of this, expecting the economy to re-accelerate also implies expecting further monetary and/or budgetary stimulus measures. However based on our understanding, these are not on the authorities’ agendas.

The graph above should be read in the following way: if the double monetary and budgetary stimulus measures had not been as strong as they were, growth would have been weaker. Let us remind readers that economic growth is the result of structural factors (demographics, institutional framework), of private economic agents’ confidence in the future (animal spirits) and of potential monetary and budgetary tail/headwinds. Generalisations are difficult considering the variety of economic situations throughout the world, yet one can say that confidence remains high in many countries and that any room for manoeuvre around monetary and budgetary factors has already shrunk significantly. So where would the great boost come from?

We believe the most likely scenario would be a continued deceleration of economic growth, which would settle at a more modest pace of around 1% in Europe, 2% in the US and 4-5% in China. Europe has now reached this point; the US is not far behind and China is certainly already there - though this cannot be proven. What conclusions can we draw from this? Weaker growth is not necessarily bad news as it confirms the fact that economic growth is now less volatile. The cycle can therefore continue and last a little longer. This context – in which recession scenarios carry low credibility and growth volatility is weaker – is very good news for financial markets, even if the economy grows at a modest pace.

Although economic risks are lower, this does not necessarily mean that investment risk is reduced across capital markets, but rather that it is changing. It seems to us that economic risks have been substituted with risks more intrinsic to financial markets, i.e. positioning risks. As investors all base their decisions on the same analysis (they look at identical indicators) they end up owning the same positions. This is why violent market swings are often caused by investors unwinding these extreme positions, rather than by the major repricing of economic scenarios. 



This final graph shows the valuation of US stocks, excluding the financial and tech sectors. It indicates high confidence levels and the lack of any real connection between the equity valuation dynamic and the economic context. While it is reassuring to buy stocks in an accelerating growth scenario, the market reality seems rather different. Rather than wondering about the re-acceleration of economic growth, we believe the key question is whether investor positioning has reached extreme levels - and if so, in which asset classes. 


Tristan Abet



The comments and opinions expressed in this article are those of the authors and not necessarily those of Candriam.