Stronger headwinds than tailwinds are driving markets lower
October has a history of being one of the most volatile months for financial markets, and this year has so far been no exception. While Wall Street has avoided parallels with the October market crashes of 1929 and 1987, it is still likely to be one of the worst months since the global financial crisis 10 years ago.
That this is happening when US gross domestic product is accelerating at an impressive 3.5 per cent annualised rate is particularly striking. Markets are no longer able to see just the positives of the US growth cycle, but are increasingly anticipating the negatives that will follow after.
And just as the US economy is starting to face headwinds from higher interest rates, a firm dollar and the fading fiscal stimulus, the same can also be said of this region, with tailwinds and headwinds likely to be vying for dominance next year.
The US situation neatly captures the paradox of conflicting pressures, both positive and negative. While strong currently, growth appears to contain the seeds of its own undoing next year. Although GDP growth rates of 3.5 per cent in the third quarter and 4.2 per cent in the second quarter are clearly impressive, the breakdown shows a shifting dynamic that is likely to result in it slowing next year.
While consumption growth held up well in the third quarter at 4 per cent annualised and government spending also rose, business investment only increased by 0.8 per cent, while equipment investment rose by just 0.4 per cent.
Even more telling residential investment actually contracted by 4 per cent, the third consecutive quarterly decline and consistent with recent monthly declines in home sales.
From these it can be seen that consumers are still being propped up by tax cuts earlier in the year, but looking ahead businesses are becoming more concerned about whether this can be maintained, especially in sectors that are highly sensitive to interest rates.
Net trade also subtracted from growth in the third quarter after contributing positively in the second quarter, a trend that is also likely to develop further should trade disputes intensify.
Further rises in interest rates, which the Fed is promising, will reflect the strength of the economy boosted by tax cuts, but which will ultimately serve to slow it down just as the positive tailwind of those tax cuts will also be dwindling next year.
The strength of the dollar on the back of higher interest rates will also make US manufacturing and exports less competitive, aggravating cost pressures that are also now becoming discernible from rising tariffs.
Finally, midterm elections in just over a week’s time are likely to result in a split Congress, which will make the passage of fresh stimulus measures much harder, and may cause Donald Trump to turn more to his default position of opposing free trade.
For this region, the challenges and headwinds in many ways reflect those of the United States, given that regional monetary policies are effectively set by the Fed and will be subject to a tightening of regional monetary conditions via higher short-term interest rates and firm local currencies, at least in the first half of next year. These will make the environment for non-oil sectors in particular more difficult.
Recent results from DP World also underline the importance for the region to avoid a full-blown trade war, with container volumes down 6.7 per cent year-on-year in the third quarter, in part because of the increased uncertainty over global trade.
Other headwinds can also be detected in the form of regional geopolitical tensions and uncertainties, which over time have an understandable impact on confidence. Fortunately, this region also contains some notable tailwinds, chiefly in the form of expanding oil output aimed at heading off an output crunch as sanctions are reimposed on Iran next month. This is likely to cancel out some of the headwinds facing the region’s non-oil sectors, but it is too early to say by how much.
All of these factors and issues starting to come into view for markets, but with little clarity about which ones will dominate in 2019. Both globally and regionally, the prospect is likely to be for a tussle between headwinds and tailwinds, but based on the recent performance of the markets, it is the fear of headwinds that is so far winning out.
October is likely to be one of the worst months since the global financial crisis 10 years ago