So how is the global economic data looking lately?  The chart below (courtesy of RBC) shows the Purchasing Managers Indices (PMIs) for major global economies over the past year.  This gives a good perspective on the slowdown in the past year as 41% of the economies were contracting (Red-PMI below 50) versus only 29% a year ago.  On the other side, the number of expanding economies (Green-PMI above 52) fell from 43% to 35%.  The Global PMI dropped from an expansionary 52.5 to a ‘neutral’ (Yellow-PMI between 50-52) 50.7 reading, with the U.S. showing the sharpest drop (58.1 down to 51.1) and China slipping to 47.3 from 50.2, putting them clearly into a ‘contractionary’ zone, which argues against the ‘official’ reported growth rate of around 7% published by the Chinese government.  Germany helped lead the Eurozone to one of the few growing regions in the past year as the Euro area PMI moved up from 50.7 to 52.3.  While clearly these are not robust numbers, at least the Euro area is showing some growth.  The emerging economies and Asia are the key areas of risk.

Purchasing Managers Indices (PMIs) for major global economies over the past year

Have commodity markets hit the bottom yet?  U.S. real gross domestic product has risen at just a 2.2 percent annual rate since the business recovery began in mid-2009 – about half the rate you’d expect after a recession.  The euro area is limping along at a 1.2 percent annual growth rate, with recovery from the 2007-2009 recession interrupted by a mild downturn in 2011-2013.  Economic gains in Japan’s stop-go economy have averaged only 1%.  The problem with this recovery, in our view, is that we are still paying for the excessive borrowing of the past cycle that ended up leading to the financial crisis in 2008.  Consumers and businesses have been reducing the excessive debt loads from the ‘spending orgy’ of 2002-07 and therefore have less money available for normal ‘recovery spending.’  The world is now eight years into this debt reduction (deleveraging) cycle.  At this rate, it will probably take more than the historical average of 10 years to complete.  Meanwhile, supplies of almost every commodity are huge and growing.  China joined the World Trade Organization in late 2001 and, not by coincidence, commodity prices took off in early 2002.  As manufacturing shifted from North America and Europe to China, it sucked up global commodity output.  From 2000 to 2014, China’s share of global copper consumption leaped from 12% to 43%.  China’s portion of iron ore purchases similarly zoomed from 16% to 43% and aluminum went from 13% to 47%.  Commodity producers and financial players bought into China’s seemingly insatiable demand and made the same big mistake that always occurs in every economic cycle:  They assumed surging demand from China would last indefinitely.  In addition to engaging in ‘mega-mergers’ that would ultimately lead to major debt and equity write-downs, producers embarked on massive projects that often take a decade to complete.  These included digging copper mines in Latin America, removing iron ore in Brazil and producing coal in Australia.  All that new capacity began to come on-stream in 2011, just as it became clear that the hoped-for post-recession return to rapid global economic growth wasn’t occurring. 

The downward pressure on commodity prices has been magnified in recent months by the realization that economic growth in China is slowing.  This is nothing new, really.  China doesn’t grow independently, but has an export-driven economy.  It imports raw materials and equipment that it uses to produce manufactured goods, largely for export.  But muted demand in North America and Europe for Chinese exports has slowed economic growth in China.  A number of hard-rock miners are so deep into new projects that they are compelled to complete them.  Closing down the ventures would be more expensive than the losses they’d incur from selling production at today’s prices.  Meanwhile, over-investment in ghost cities and building of excess infrastructure, in which China engaged to create jobs, has spawned huge debts.  Some estimates of the debt in the Chinese ‘shadow banking’ system are in excess of US$16 trillion.  We also have seen private surveys which estimate that real growth in China is about 3-4%, or about half the 7-per-cent official number!   

Not much was made of the slowdown in China, though, until stocks went off the cliff in June. The Shanghai index fell 40% in the ensuing 3 months despite Beijing’s clumsy and heavy-handed efforts to support equities, including spending over US$350-billion to purchase stocks as well as prohibiting large domestic investors from selling stocks and freezing the trading on a substantial number of individual stocks.  Devaluation of the yuan soon followed.  To prevent the pegged yuan from collapsing – and accommodate the rush of money out of China – the government has sold about $400-billion of its nearly $4-trillion in foreign currency reserves to buy yuan.

Emerging markets also have a China problem.  The nation’s $11.4 trillion economy is slowing, and taking the rest of the developing world with it.  Net capital flows for global emerging markets will be negative in 2015, the first time that has happened since 1988.  Net outflows for the year are projected at $541 billion, driven by a sustained slowdown in EM growth and uncertainty about China.  In other words, investors will pull more money out of emerging markets than they will pump in.  Relief from the Federal Reserve’s decision to delay its first interest rate hike in a decade has proved to be short-lived for EM’s amid fresh evidence of a slowing Chinese economy, precipitous currency declines, a sustained slide in commodity prices, and political uncertainty in countries such as Brazil and Turkey.  The fact that aggregate emerging market equity indices have lost almost a quarter of their value since reaching highs in late April have led investors to ask whether this is the beginning of another EM crisis.

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