Earlier this week the IMF released its latest economic outlook. It was the debut of the newly appointed and first female IMF chief economist, Gita Gopinath.
She observed that “While global growth in 2018 remained close to post crisis highs, the global expansion is weakening”. Indeed, the slowdown in growth has been somewhat surprising and high-frequency data (mainly PMIs) continued to disappoint into 2019.
The IMF’s latest growth projections have been adjusted modestly, with global economic growth slowing by about 0.2% to 3.5% in 2019 mainly due to a drag from advanced economies (Germany, Italy and France in particular).
Of course, we should all know by now that these forecasts are of very little use. To point this out is not to attack the IMF, but merely to acknowledge how impossible such forecasts are, no matter who is attempting them (as Greg Ip wrote yesterday “In Davos, nobody knows anything, and that’s the problem”).
But, while the forecasts themselves should probably be ignored, the IMF’s outlook arguably represent a useful indicator of consensus views in markets today, offer a mirror to our own fears or hope.
Political risks: encouraging focus on ‘known unknowns’
Interestingly, Mrs Gopinath also spent some time describing the potential risks to the outlook, and suggested that the key downside risks are not economic or financial in nature (like high corporate leverage, elevated EM debt or falling earnings…), but mainly political. Trade tensions, Italian politics, Brexit and US federal shutdown were all cited as potential sources of further global growth decline.
How much can we know about the unfolding of such political events? And most importantly, is the equity market providing us enough compensation to take on those risks today?
Arguably for investors, it should be encouraging when market participants begin to focus on worst case scenarios on issues that are ‘doubly unknowable,’ both in terms of the outcomes themselves, and the impact of those outcomes on the financial system.
What we do know is that since the beginning of 2018, earnings yields on the MSCI All Country World index have risen more than 1.5% to about 7.5%. Because of the very fears outlined by the IMF, prices now imply that investors being offered 1.5% more each year to face such political and other risks (at least in theory, if not in practice).
In some markets, like Japan, we are receiving 2.5% more than a year ago and the cheapest valuations since the midst of the Eurozone crisis. Incidentally, the IMF 2019 growth projections for the Japanese economy improved by 0.2% from last October to 1.1%!
On the back of weaker growth projections and further downside risks, the IMF managing director Cristine Lagarde gave a strong message and urged political institutions to resolve some of the most pressing political issues today and to build resilience, enhance inclusiveness and boost collaboration across nations.
If this were to happen, there could be some recovery in equity markets beyond what we have already seen in January. The background appears to be more supportive than sentiment suggests: economic data do not yet suggest a sustained- as opposed to cyclical – slowdown, many labour markets continue to strengthen, and the inflation outlook remains benign.
This can clearly deteriorate, but we are now being offered greater compensation for that risk, including in some parts of the bond market. Were uncertainty around political issues to abate, improved sentiment could prompt significant potential returns in equity markets.
Whether this happens or not is unlikely to be influenced, or predicted by the IMF.