31 Jan 2018
Expansions come and expansions go. We see this one hanging around for longer than many expect. Yes, the G7 output gap – the difference between actual output and economic potential – is shrinking as the US economy has joined Germany, the UK and Canada in running near full capacity. See the Filling up chart (below). Yet when growth is only slightly above trend, economies can run beyond potential for a long time before peaking, our analysis shows. And plenty of spare capacity in parts of Europe means the developed world as a whole (not just the G7) still has a hefty output gap. This suggests to us that the remaining time to this cycle’s peak is likely years, not quarters.
Sources: BlackRock Investment Institute, with data from Thomson Reuters and IMF, November 2017. Notes: The bars show the output gap range since 1980 as estimated by the IMF, with dots indicating the 2017 estimate. The output gap is the difference between actual and potential GDP as a percent of potential GDP.
What could change this dynamic? Deficit-funded tax cuts could push US growth further above trend, leading to a faster build-up of imbalances that hasten the cycle’s end. The longer a cycle lasts, the more investors worry about its demise. Yet even if positive growth surprises are behind us, we believe the above-trend level of growth should be positive for risk assets.
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The figures shown relate to past performance. Past performance is not a reliable indicator of current or future results and should not be the sole factor of consideration when selecting a product or strategy. Sources: BlackRock Investment Institute, with data from Thomson Reuters, November 2017.
Notes: The lines show analysts’ 12-month forward earnings-per-share estimates for the MSCI World and MSCI Emerging Markets indexes, rebased to 100 at the start of 2011.
Above-trend economic growth is helping companies deliver on earnings. Japan and emerging market (EM) Asia may be hard-pressed to repeat their surprisingly strong earnings showing in 2018, but steady global growth, robust trade and commodity price stability should be supportive. The All together now chart (above) shows the breadth of the recovery from the 2014-2015 oil and commodities downturn, with EMs likely having room for catch-up.
We believe EM economies can withstand a moderate slowdown in China, and see growth momentum as many are in an earlier stage of expansion than developed markets. Brazil and Russia have emerged from recession, while we see India bouncing back from a reform-induced slowdown. This should provide cyclical support for EM equities, beyond the structural factors mentioned on page 12 of our Global Investment Outlook. In EM debt, we expect coupon-like market returns as 2017’s positives – low US rates and a weak dollar, accelerating Chinese growth, and EM monetary easing – reverse or fade.
This is an excerpt from the BlackRock Investment Institute's Global Investment Outlook 2018.
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