Chart of the Day:

Manufacturing PMI’s for South Korea and Taiwan, widely followed as leading indicators of world trade, fell further into contractionary territory during February. Source: Nikkei


Half an hour after the New York open, US equity indices shifted from modest gains to significant losses. The S&P 500 lost 0.4%, its fourth loss in the past five sessions. At the day’s worst, the major indices had fallen more than 1%. Germany’s DAX index traded tick for tick with the S&P, a clear indication that one big risk factor was affecting all equity valuations

Analysts complained that there was no particular catalyst for the drop. In fact, there was an obvious catalyst, namely a weak world economy and a weakening US economy. The Atlanta Fed reaffirmed its GDPNow model estimate of just 0.3% annualized growth during the 1st quarter after the Census Bureau reported a 0.6% drop in December construction spending (versus an expected 0.1% gain). The decline was broadly based, affecting health care names the most (UnitedHealth and Walgreens) as well as China-linked names like Boeing and cloud-related tech companies.

The most popular ETF proxy for the Chinese H-share market, FXI, gained 0.4%. Consensus opinion now expects a trade deal of some kind between the US and China, and major press outlets over the weekend carried firm predictions of a deal in the making, with the evident encouragement of the Trump Administration.

The failure of US markets to rally on what is, after all, good news, suggests that it is harder to un-break the glass after the fact than to break it before the fact. The tariff war has introduced a new dimension of uncertainty into world trade. A great deal of the prosperity of the past ten years has come from the globalization of supply chains, which increase corporate efficiency and reduce the prices of high tech goods. Even if Trump and Xi Jinping sign a deal later this month, it will affirm rather than allay the reemergence of mercantilism as a guide to economic policy.

World trade volume contracted during 2018, as I reported earlier, and it looks like it is still contracting. Japan’s February reading on the Nikkei Manufacturing PMI came in at 48.9, and Germany’s at 47.6. China’s manufacturing PMI stood at 49.2 in February, slightly contractionary, but its composite PMI was 52.4, decidedly in positive territory.

The difference between China and the others is simple: Shrinking world trade hurts China, but China’s growth during the past ten years has come mainly from domestic demand rather than exports, and China has the capacity to increase domestic demand. Germany, Japan, Taiwan and South Korea do not: When export demand shrinks, output shrinks with it.

There are a number of factors dragging on world trade, for example, overcapacity in the world auto industry, and the saturation of the smartphone market, but the killer blow to world trade came from the Trump Administration, whose tariff war on China froze capital investment plans around the world by creating uncertainty about the viability of existing supply chains.

China may have lost about half a percentage point of GDP growth, from the mid-6% range last year to 6% or so in 2018. But the data suggest that collateral damage among America’s allies was far more painful than the damage to China, Washington’s intended target. That makes Japan, South Korea, Taiwan and Germany all the more dependent on China’s economic stimulus, especially as growth in the US has slowed to a crawl.

US consumers pulled back sharply in December, as I reported yesterday, and the now-popular argument that CapEx will replace consumption as a growth leader is dubious. Citibank analysts last week observed that equity buybacks in the US exceed capital spending for the first time since 2007. Citibank predicts that US corporations will return more than $3 to investors through dividends and buybacks for every $2 they spend on capital equipment

Orders for non-defense capital equipment excluding aircraft are down by 20% in real terms from the level of late 2012. The corporate tax cut of late 2017 appears to have had no impact whatever on CapEx. It seems fanciful to predict that CapEx will pick up during 2019 in the context of flagging consumption and shrinking world trade.