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Economic growth expected to see moderate acceleration

Global Overview

August 2017

Economic growth expected to see moderate acceleration

The global economic growth outlook remains healthy, as the major developed countries are expected to expand faster during the second half of this year. Recent trends suggest that consumer sentiment remains robust in the U.S. as the labor market continues to strengthen. Growth forecasts for the Eurozone have been revised higher, though the U.K. could face a moderate slowdown in the coming quarters. The Japanese economy is also gaining speed, helped by the improved external demand for manufactured goods. The recovery in commodity prices should help other developed countries such as Canada and Australia. The outlook for emerging markets is also healthy. China is expected to sustain growth above 6.5% while India is likely to recover from the recent slowdown. Brazil and Russia continue to recover from recessions, while the major South East Asian countries are also expanding at a good pace.

Despite these positive signals, major developed market central banks remain cautious about reversing quantitative easing or raising interest rates. Inflation levels in most of these countries remain well below target and wage gains have so far been moderate, despite the decline in unemployment rates. Fewer rate hikes are expected from the U.S. Federal Reserve while the European Central Bank is continuing its bond purchases through the end of this year. With the exception of Brazil and possibly Indonesia, most central banks in emerging countries are likely to hold interest rates at current levels.

Global manufacturing output in August expanded at the fastest pace in recent years, as the Eurozone continued to see strong gains. Most other developed countries, including the U.S., also reported expansions as both domestic and external demand remain supportive. The emerging economies saw a recovery in August, after the relatively subdued trends during the first half. The robust recovery in export demand is driving manufacturing growth in Asia while higher commodity prices should help mining activity in Latin America and elsewhere. In August, global services activity also picked up speed to the fastest pace in nearly two years.

 

Global industry spotlight for the month: Technology

The technology sector continues to see strong growth in revenues and earnings, especially in segments such as ecommerce, online entertainment, and web-based services. In the hardware and devices area, continuous innovations and new product features have sustained demand growth. The robust sales volume expansion for cellular phones and other products have also benefited component manufacturers across the globe as well. Despite the rapid pace of expansion, many of these market segments are far from saturation. Relatively low market acceptance for some of these services in less developed countries offer the possibility of accelerated growth for several years to come. Nevertheless, current equity market valuations of some of these businesses already factor in part of the future revenue expansion. Those businesses that have positive cash flows, and hence are less dependent on external capital, appear better placed to survive any slowdown in demand growth.

The remarkable valuation expansion over the last several years has lifted the technology sector to one of the largest sectors in most global equity market indexes. The sector now accounts for more than 15% of the global free float market capitalization. In emerging markets, the technology sector dominates with more than a 28% share of the free float capitalization. The largest technology companies are now household names, disrupting older business models, and are widely followed by analysts. These unprecedented changes and the pace of growth has immensely benefited investors and there is broad consensus that the expansion can continue.

Cellphones and other handheld devices have become ubiquitous, even in large emerging economies where average income levels are still low. Despite this apparent market saturation, manufacturers of handheld devices such as cellphones continue to see healthy demand from product replacement and upgrades. With the addition of new functions and updates, these devices have even become effective tools in improving workplace productivity. As a result, the leading manufacturers still command considerable pricing power.  Given the potential for product upgrades in some of the large emerging markets, where consumers are becoming more affluent, the demand outlook for devices remains bright.

Manufacturers of chipsets and other components have also benefited from strong demand for devices. Industry consolidation in the past has left only a handful of chipset manufacturers and product assemblers that have the scale and resources to meet the volume demand, as well as stay ahead of technology evolution. These manufacturers have seen very strong earnings expansion in recent quarters, and are not expected to face margin pressures in the near term. Other components that are mostly device specific allow opportunities for smaller manufacturers that are efficient enough. However, the fortunes of these smaller component manufacturers often depend on the acceptance of specific products in the market.

The market valuations of ecommerce and other online service providers continue to expand as most of these businesses are tapping new technologies to create demand, or disrupting and replacing old business models. This is most visible in sectors such as retail where older players are struggling. The ability to offer more services on currently available platforms set apart the providers that can continue to grow for several years. There is also potential for geographic expansion as most of the innovations can be easily adapted to markets across the globe. Here again, the current leaders with access to technology, capital and other resources have the advantage over smaller rivals. They are better placed to enter new market segments or geographies, including by way of acquisitions.

While the business prospects remain upbeat for the next several years, the current equity valuations already account for at least part of the future revenue upside. As these market segments continue to evolve and mature, more consolidation is also likely. Companies that are currently dominant, or have healthy cash flows, appear better placed to survive any decline in demand.

 

 

 

 

 

 

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