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Snowy uneven ground from above.

The global economy is transitioning from US exceptionalism to global conformity, which means global growth is on a stronger footing. The European economy has finally woken up. Beijing’s social contract will keep China’s growth from slowing down despite its property overhang. Solid growth on a broader base means that equities will continue to rise, whilst core inflation and hence interest rates will fall only gradually.

Earnings drive stock prices

Company earnings drive stock prices. On a macro level earnings are driven revenue growth which in turn is driven by economic growth. The other component of earnings are margins, which cannot rise indefinitely. As a corollary, large equity drawdowns are the result of economic recessions which collapses earnings.

Hence, asset allocation is mostly a game of economy watching. The good news is that presently the global economy is humming along, and the growth base is broadening out. Hence the rise in equity prices is set to continue. 

Exhibit 1: Earnings drive stock prices

Exhibit 2: Stock markets have had a good run

From US exceptionalism to global conformity

For the last few years, the global economy has relied on the largesse of the US consumer. The US economy has defied doomsayers and kept on growing at a rapid clip of three percent per year. Hence the US economy has outpaced its normal or long run potential growth rate, which is a little below two percent per annum according to Fed estimates.  

The good news is that the global economy is no longer reliant on US exceptionalism. Other forces are coming into play, namely Europe, and the industrial cycle. In addition, China is set to weather the implosion of its real estate bubble. Beijing has little choice. 

Europe stirs

The European economy has been dormant for the last few years, but in the first quarter of this year the economy finally stirred. Annualised GDP growth picked up to around 1.3 percent, which is trend growth for Europe. JP Morgan has raised its estimate for European growth to pick up to an annualised rate of two percent. Forward looking indicators such as purchasing manager indices (PMI) also point towards accelerating economic activity.  

Exhibit 3: The European economy has finally woken up

In both the US and Europe, the mainstay of the economy is the consumer. The US consumer accounts for close to 70 percent and the European consumer 60 percent of GDP. Both economies have seen strong labour markets with full employment and rapid wage growth. With inflation falling quickly rapid wage increase also mean real wage rises.  

Despite similar labour market backdrops the US consumer embarked on a spending spree whilst Europeans saved their income. The US savings rate dropped from 10 percent to 3.2 percent. The European saving rate has held steady at close to 15 percent which is higher than it was prior to corona. The acceleration and even staying power of European economic growth depends crucially on whether the European consumer finally relents and goes on to spend their excess savings. 

The housing market is to blame

Some have argued that American and European consumers reacted differently because of the proximity of the Russia-Ukraine war and the ensuing European energy crisis. However, European consumption stopped growing in the autumn of 2021, before anyone, except for the CIA, knew that Russia would invade Ukraine. Hence the war is not a great culprit for the European savings glut. 

A more likely explanation is the housing market. In most countries housing constitutes the bulk of household wealth. European and later Chinese house prices fell in a major way, but US house prices have kept on climbing. Hence recent years have seen European and Chinese wealth erode whereas, Americans have never been as wealthy as now. It is likely that Europeans have reacted to falling wealth by saving and attempting to repair their balance sheets. Americans never went out celebrated their rising fortunes. 

ECB policy is key for housing and hence consumption

Interest rates are key to stabilising housing markets along with economic growth. The ECB is set to cut its policy rates in June. The subsequent pace of rate cuts will be determined by how quickly inflation cools. As European GDP and forward-looking economic indicators have picked up the market has lowered the number of cuts this year from seven to two. Nevertheless, the commencement of rate cuts may be enough to put a floor on housing prices, which would in turn spur Europeans to begin spending again. Years of high wages and little consumption mean that Europeans have plenty of excess savings.  

China’s social bargain is akin to a Fed put

The MSCI China index has been one of the best performing markets this year. It has risen almost 12 percent since the beginning of the year or around 25 percent from its lows. These gains follow a terrible 2023, when the China index lost a third of its value from its peak in 2023. 

China’s ability to continue growing at close to a five percent rate amid a real estate implosion is a respectable show of determination. How a country can continue to defy business cycles is something only a mixed economy can offer and not without a price. 

The Middle Kingdom is transitioning from an economy powered by a real estate boom, into a more balanced economy driven by the consumer. The government has been unwilling to completely offset the drag from a falling real estate sector but is neither willing to tolerate a recession to clear the debris. 

The fallout from the property crisis has been softened through multiple channels. Beijing has ordered banks to finance the purchase of real estate by local authorities to limit the fall in house prices. Beijing is also attempting to increase high value exports such as solar panels and electric vehicles, although the US has already responded by raising tariffs. Europe will also respond to Chinese dumping measures although less extensively as the US. Beijing has also propped up industrial production although it is hard to see the benefit as the export channel will be closed by the West and there is already industrial overproduction. 

The key to recovery is to engage the Chinese consumer who is holding back their consumer. Financial repression has meant that there are limited investment options available to the Chinese. Hence the Chinese, more than in anywhere else, have invested their wealth in real estate. Hence, just like in Europe one needs to see house and property prices stabilise to galvanise the Chinese consumers into action. What is in store is a protracted game as the government is unwilling to let housing markets reach a new lower equilibrium except gradually. 

Regardless Beijing will ensure that economic growth only slows marginally, since Beijing’s social contract with the Chinese people is one of exchanging freedom for prosperity. That social contract may be under pressure, but there is little risk of an outright breach of contract. Fundamentally all governments engage in such a Faustian bargain or as former US president Bill Clinton’s strategist James Carville put it in 1992, “It’s the economy stupid.” 


The global economy is set to keep on growing, whilst the growth base is widening to encompass the eurozone and the industrial cycle is perking up. The global economy is hence transitioning from US exceptionalism to global conformity.  

Beijing’s social contract with the Chinese means that the capital will not allow the economy to succumb to property pressures. The continuation of global economic growth means that equities will continue to rise, whilst core inflation and interest rates will gradually fall.  

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