Industrial bellwether signals the impact of uncertainty

Friday, 25th October 2019 08:55 - by Shant

For over 18 months now, the world economy has been suffering from ever-increasing uncertainty over trade tensions between the US and China, with effective policy action starting with the announcement from President Trump back in January/February 2018 of tariffs on certain products from China including solar panels.  This was followed up by broader tariffs on aluminium and steel a few months later (on all countries), though naturally, China was at the forefront of policy focus given the sizeable imports of steel from the world's second-largest economy.  Since then, tensions have only escalated with a series of yet more levies, increased in some cases to 30% - the last of which were in the summer and put into effect at the start of September.  Given the President's long-held view that the US has been at a trade disadvantage to China, his combative policy measures should have come as little surprise, but this does little to address the impact they are having on both the US and global economy, and more significantly, at a time when the economic cycle is - well, let's say, past its peak.  

Pundits assumed the US would be largely resilient to the effects of these combative measures.  In recent months, however, forward looking indicators, such as the ISM surveys have clearly identified a notable degree of restraint in business investment - a worrying dynamic which has featured in Fed chair Powell's recent press conferences, accompanying moves to lower Fed Funds rates in the process.  To date, interest rates have been cut by 50bps since the start of the year, and markets are looking for more into the end of the year. The question now is, whether this in itself will be enough to raise business sentiment given the above assumption that the global economy is slowing down as a function of the economic cycle.

Irrespective of trade tensions, there is no denying the slowdown in China, and how this has and will continue to undermine growth prospects all over the world.  Over the last 2-3 decades, China has embarked on a huge infrastructure building process which has hitherto bolstered global exports around the world.  Germany's fortunes have taken a turn for the worst, and in no small part due to reduced demand out of China.  At some point, it is fair to assume that this will recover, as China's metamorphosis to a consumer driver economy eventually gains traction.  This is their ultimate aim, though how long will this take?  We look at Australia also, and here we have not seen in recession for the best part of 30 years.  This, we can fairly deduce, is significantly attributed to steady export demand during China's infrastructure spending period.  Again, we note a slowdown (in Australia), though the domestic economy is holding its ground as labour markets continue to expand for now.  

Closer to the US, however, results from Caterpillar this week highlighted weakening business investment, with its network of retailers reluctant to add to their inventory due to the trade tensions, according to the CEO Jim Umpleby.  Caterpillar's profit per share for the third quarter was reported at $2.66 per share, falling well short of market expectations of $2.88.  Further to that, total sales and revenue were down over 5% from the same period last year, totalling $12.76bln compared to forecasts closer to $13.6bln.  Consequently, Caterpillar has slashed its full year profits back to $10.90-11.40 a share against early year calls in the $12.06-13.06 range.

Looking ahead, the heavy machinery marker said that they expect the final quarter of the year to see further inventory reductions, resulting in flat demand.  Along with facing these trade policy directives, the company is also up against the increased competition.  At a time of dwindling demand, these headwinds are building up into a perfect storm which will only be partially alleviated by some form of resolution to the trade spat between the economic superpowers.  While the US has reported progress in talks, a fast-track deal could not come at a better time.  The manufacturing industry would greatly benefit from some positive news to boost sentiment, and while one assumes that the White House administration is working hard to achieve this, political will seems to have underestimated the staying power of China in these negotiations.  One suspects that if and when this hits the broader economy - and there are tentative signs that this is indeed filtering through into consumption - then going into next years elections, realisation may finally set in and prompt the US to soften their stance.  

The White House may be gambling with time here, but the ongoing tensions are hurting corporate America and Caterpillar's results should serve as a clear warning, if not the very words of caution issued by the CEO.  The US stock markets as a whole continue to hang on hope (of a trade deal), yet in terms of timing and essence, we have to start asking whether this alone justifies elevated levels of valuation - certainly in a broader scope.  Differentiation naturally applies, and more so in times of potential, upcoming hardship.  The signals keep on coming, but is the market listening?

The Writer's views are their own, not a representation of London South East's. No advice is inferred or given. If you require financial advice, please seek an Independent Financial Adviser.