It is amazing how quickly sentiment changes in stock markets. Last February, we all were worried about deflation and hard landing in China, nearly 15 months later, world seems a better place. Since February 2016 markets faced Brexit shock in Europe, unconventional leadership in US and to top it all demonetization, repudiating 85% of the currency in India, yet 3 months post each of these events markets were trading higher.
Not to say that markets were oblivious of reality or gravity of the situation, but still the consumer and business confidence post an initial dip bounced back sharply. The reassurance to the consumer was absence of tail risk and a long term path towards improving productivity and enhancing competitiveness.
As we write, the strong consumer and business confidence is reflected in robust PMI data, IFO expectation survey and consumer surveys across the world. The positive impact of this is in revival of Asian exports, fairly broad-based improvement across all key demand regions. However, despite the recovery in exports, the strength of economic data or hard data, GDP growth, IIP growth is far lower than the confidence shown by the soft data i.e business or confidence surveys.
It is amazing how often in last 3-4 years, corporates have commented on seeing green shoots of demand which fade in couple of quarters. In a normal business cycle, an embryonic recovery builds on itself and gets entrenched as consumer and business confidence gets positive reinforcements. Often in early upcycle, induced by promotions, consumer who been in a shell starts spending, businesses see higher revenues but more importantly because of costs being relatively fixed, significantly higher profits. These profits go back in the economy in form of higher wages and higher capital expenditure to meet rising future demand creating a virtuous cycle.
The million dollar question is if and when will the soft and hard data converge in the current cycle? Historically, we have seen that the soft data leads hard data by about 6-9 months. Thus, taking the same precedent, we believe that as businesses get confidence on demand recovery and consumers get used to better economic conditions; both will spend more, unleashing animal spirits in the economy. From a market perspective, the enabling conditions would be Trump administration kick starting private capital expenditure cycle through tax cuts. The corporates accustomed to cash hoards and buybacks in recent years are likely to then switch tracks as age of capital stock is fairly high in US. Furthermore, any progress on infrastructure improvement would be added positive. Meanwhile in China, while exports boost GDP growth, it’s important that the government continues with supply side reform of cutting excess capacity and controls the credit bubble.
With the top 2 economies in the world, nearly 37% of world GDP, getting their act right, it is highly likely both businesses and consumer will believe in a better future and the markets can escape the low growth rut.
By Rahul Chadha , CIO, Mirae Asset Global Investments Hong Kong
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