Gauging global growth

18 October 2017 | Markets and Economy


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From the ongoing economic recovery in the United States to China's slowdown, many investors are looking at GDP growth to help shape their decisions. Andrew Patterson, senior economist in Vanguard Investment Strategy Group, discusses growth levels in the US, Europe and Asia and answers questions on whether sustained growth and stable inflation could mean a less severe recession in the future.

Lara de la Iglesia (moderator): What are your thoughts regarding GDP growth in the US, the European Union, China, Japan and emerging markets? Maybe break that down for me a little bit.

Andrew Patterson (Vanguard senior economist): Yeah, that's quite a group, quite a group there.

Lara de la Iglesia: Yeah, we're covering a lot of territory.

Andrew Patterson: Right. So I mentioned earlier our expectations for US growth, somewhere around 2.5%. Heading into the year, that may have been a bit toward the lower end of the range of expectations. A lot of prognosticators [were] expecting growth of 3% or more. They've actually – with that measured approach to the overly optimistic assumptions heading into the year – they may have come back down towards our 2.5% target.

In Europe, things have progressed a little bit faster than expected from the recovery standpoint. You're seeing growth somewhere in the high 1% range as opposed to mid-1% range that we would have expected heading into the year.

Japan, another somewhat positive surprise, you're seeing growth there of around 1%. We'd expect that to continue for the rest of the year, although they have some underlying structural issues they absolutely need to address.

And then emerging markets, China chief among those, always very front of mind. Expectation is for them to continue to slow from a growth perspective. "Hard landing" has not been our base case – continues to not be our base case. Hard landing being growth of, call it 3%–4%. We think this slowdown in growth is going to be very long-term in nature and gradual. So you could see growth of around 6.5% in China this year. That has implications for emerging markets, particularly commodity producers who depend, to a large degree, not only on China, but on other developed markets for trade and are impacted by policies of developed markets, such as Federal Reserve policy here in the United States that impacts capital flows in emerging markets.

So growth there [is] expected to be somewhat higher than developed markets, call it 4.5%, China included. But that said, that's not without reason for concern.

Lara de la Iglesia: If the US economy continues to grow at about 2% with stable inflation, can we infer that the expansion might go on longer and that we might expect a less severe recession the next time around?

Andrew Patterson: Forecasting is humbling. Forecasting recessions is very, very humbling.

Lara de la Iglesia: I had a feeling you were going to say that.

Andrew Patterson: Absolutely. So growth of around 2% – a lot of commentators have pointed to that as evidence that this recovery has not been as rapid as those in the past, and that's true. You haven't seen the 3.5%, 4%, 4.5% growth people may have become accustomed to pre-crisis.

That said, if you look at the underlying fundamentals, be it demographics and the labour force participation, be it capital accumulation, those wouldn't really point to growth much beyond 2% going forward, absent any sort of structural change or big policy regime shift. So I would say that 2%, it's really fundamentally sound.

Regarding the question of inflation, I mentioned before we're doing some work around that. In our view, the Fed achieving their 2% goal, they're likely to get there in coming years, but being able to maintain that and even see inflation above that, it's difficult to see an environment where that occurs, because there [are] a lot of forces constraining inflation right now, be it China and their slowing growth, be it technology, the impacts of technology.

Lara de la Iglesia: We've done a lot of research on that. It's part of our economic outlook, right?

Andrew Patterson: Absolutely. Some upcoming research and some research that came out of our 2017 paper that showed the impact that technological advances have had on prices, and that's likely to be with us for some time.

So, somewhat lower inflation, but in terms of timing of recession, very rarely do recoveries die of "old age". Just because this recovery's gone on a bit longer doesn't mean that it has to necessarily come to an abrupt end in the immediate term.

Lara de la Iglesia: So let me ask you a follow-up question on that, which just came in from one of our viewers. What do you feel could be triggering an event of the next recession? So it might be hard to predict when. What are the things that we're looking at that may trigger?

Andrew Patterson: So we're looking very much at those geopolitical risks we talked about, if there's an exogenous shock, some sort of war, some sort of deterioration of diplomatic relationships. We're looking to China, right? I mentioned before our base case is that they're able to gradually slow their economy and transition to a developed-market model type of growth that's more dependent upon the consumer.

That said, this is the first time an economy of that size has tried this type of transition, so there could be bumps along the way. And outside of that, it's a policy mistake, be it from the Federal Reserve – if they were to tighten [interest rates] too rapidly. I would qualify their pace of tightening so to speak right now, rather than tightening, more so gradual removal of extraordinarily easy accommodation, taking a very slow and gradual approach to this.

If they were to get behind the curve and start to see inflation really pick up, that wouldn't be our base case, but that could be an unexpected event. They may see themselves having to tighten a bit faster. That could very well push us into recession.

So three big factors there that we're always discussing within the group.

Lara de la Iglesia: I'm going to ask a slightly different question along similar lines here, from Michael. What are some warning signs to look for as the bull market matures, then? Should we look at lower oil, higher rates from the Fed – you just spoke to that a bit – [US President Donald] Trump's agenda stalling? Right now none of these seem to be deterring the new highs. A little bit of mix of what you were talking about there and some of the noise. What are your thoughts on that?

Andrew Patterson: Absolutely. So I would pay attention, again, for the lack of a better answer, to really all those things. But, at the same time, there's so many different factors that could affect equity markets, or fixed income markets for that matter, at any given point in time.

Trying to pinpoint one specific item to focus in on – very, very difficult to do. To say that just because there's low oil prices, [it] portends an equity market correction. We saw that back in early 2016. We had to question that because for the most part low oil prices should be a good thing for the US economy, and it turned out that that was occurring at the same time that we were having a pullback in equity markets, in equity prices.

I think about things like policy, right, you think about things like geopolitical events. All those factors could potentially play a role in the next downturn, but, again, trying to predict those or following one or two or many of those day in and day out, it doesn't necessarily lead to the best outcomes, both from an investment-success standpoint and, for that matter, from a psychological standpoint. So we think it's best that investors come up with a longer-term strategic approach to investing regardless of the environment, be it economic changes or changes in political regimes. That really shouldn't matter at the end of the day.

Lara de la Iglesia: Right, which is something that the advisers can absolutely help them along those lines with. Monitor, be mindful, be aware, but set the long-term approach, right? And help adhere to that.

Andrew Patterson: It's 100%. It's very hard to go into these types of conversations because there are a lot of concerns, right, geopolitical concerns, concerns around policy, maybe more so today than there had been in the past. So you can't just go in and have a conversation, say, "Don't worry about any of that. Just stay the course."

You have to have sound reasoning for why you should stay the course, and that's where advisers can help their clients in understanding that just because the Fed raised interest rates by 25 basis points, doesn't mean you need to defer from your [hypothetical] 55/45 stock/bond portfolio or your 60/40 stock/bond portfolio.

Lara de la Iglesia: Right. Thank you.

Important information:

This information is directed at professional investors and should not be distributed to, or relied upon by, retail investors. It is for educational purposes only and is not a recommendation or solicitation to buy or sell investments.

This video is designed for use by, and is directed only at, persons resident in the UK.

The value of investments, and the income from them, may fall or rise and investors may get back less than they invested. Any projections should be regarded as hypothetical in nature and do not reflect or guarantee future results.

The opinions expressed in this video are those of the individual speakers and may not be representative of Vanguard Asset Management, Ltd.

This video was produced by The Vanguard Group, Inc. It is issued by Vanguard Asset Management, Ltd, which is authorised and regulated in the UK by the Financial Conduct Authority.


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