Global Fractures

• Japan’s root problems: mismanagement of product strategy
• The spread of ‘Japanisation’ to the US is therefore inconceivable
• Europe has the symptoms: slow growth, deflation threat, negative rates
• But in the EA, slower growth has resulted from the euro structure
• Products are competitive and labour forces do not accept wage cuts
• Divergence of German and Italian labour costs is especially acute
• Over time, the chief reason has become falling Italian productivity
• ECB interest rates are negative to protect uncompetitive Italy
• Germany has become indefinitely undervalued in labour costs
• Excessive budget austerity has made the whole EA export-dependent
• Growth potential is slipping, as in Japan, but both may ‘muddle through’
• Populism adds to EA vulnerability to accidents

• Risk: We turn less negative but still think the long list of potential upsets ahead merits a continued negative call on risk.
• Turkey: We raise our call on equities to positive, which we view as a short-term tactical move owing to the expected sharp fall in inflation in September.
• Russia: Prospects for further declines in inflation and the key policy rate remain solid; we maintain our positive call on all Russian securities.
• Brazil: We continue our positive rating on Brazil ahead of the final passage of pension reform and continued easing by Banco Central.

Economics: A slipping grasp on growth

• Markets ignored the last rate cut, balance sheet up next
• Industry slowing, discretionary spending too; home sales are up

Markets: small-cap premium conundrum

• Slowing aggregate profit growth reflects weaker domestic earnings
• Small-caps have fared worse as a result; fundamentals appear weak
• Yet small-cap stocks still trade at premium

Politics: Impeachment means Trump needs China

• Pelosi’s narrow needle to thread for Democrats to benefit
• Constitutional principles are subordinate to the economy and polls
• Trumps needs a trade deal for growth, China playing a different game
• Global problems rise during impeachment; Ukraine pivots to Russia?

With yields inverted and a slump in global manufacturing, investors are increasingly worried about the prospect of a US recession. We do not think recession is the most likely outcome over the next 12 months, but there is a risk that a period of sluggish growth and disappointing corporate earnings turns into something nastier. Here’s how...