Chart of the week – Services to the rescue?

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Are you being served?, the British 1970s-1980s department store sitcom asked, and increasingly, it is a question for markets and investors too these days.

  • What is happening to consumer appetite, notably for services?
  • Can we count on the ability of the sector to offset what is becoming a deepening slump on the manufacturing side of many economies?

For many countries, the services sector now dwarfs manufacturing, marking a shift in the make-up of gross domestic product (GDP) over recent decades. This has led to services growth becoming a significant contributor to overall GDP growth as it accounts for three quarters of GDP in high-income countries such as the US and more than half in low and middle-income countries (see exhibit 1) [1].

Exhibit 1: Services as a percentage of GDP (value added)

Exhibit 1: Services as a percentage of GDP (value added)

Source: World Bank, October 2019

As the share of services has grown, the contribution of industry – and agriculture – has declined, not just the contribution to overall output, but to employment as well. Between 70% and 80% of jobs in OECD countries are in industries such as travel, retail, insurance and finance, and communications and computer services. It is worth noting that for trade, exports of manufactured goods have remained the dominant category, although exports of services – and agricultural goods – have seen the fastest growth [1].

At the core of the economy and growth

Clearly, the services sector is essential for the world economy and hence its prospects matter for markets and investors. While recent forward-looking data on manufacturing have disappointed and bolstered expectations of a profound slowdown in growth, accompanying questions have centred on the services sector. Concerns surround contamination as well as hopes that a strong labour market, rising wages and uncharacteristically low interest rates could keep the worst at bay.

Monthly purchasing managers indices (PMIs) feature among the survey data scoured for clues on the direction of the economy and the numbers are seen as advance ‘warning signals’. Historically, they have indicated trends several weeks ahead of official data – e.g. in the case of manufacturing output numbers – and several months ahead of GDP figures.

Hence the concern after the latest ISM (Institute for Supply Management) releases pointed to contracting factory activity. It was the second month in a row that the US manufacturing figure (covering areas ranging from new orders and jobs to prices and exports) has declined, falling to its lowest in more than a decade.

More broadly, the manufacturing indicator dropped across almost all advanced economies. For the global figure, this was for the fifth month running. Recent data on China foreshadowed muted growth, too.

What then of the services sector?

Recent data appears to suggest the weakness in manufacturing is spreading to other areas of the economy, notably services. In the eurozone, the slowdown was sharpest in Germany – traditionally Europe’s powerhouse. The economy is reeling from problems in the car, banking and utility sectors and a drop in demand from China, and the government looks unlikely to prime the pump to shore up domestic demand. If anywhere, fiscal measures look more probable in China.

The latest US services gauge came in with a reading above 50 – signalling continued growth, but at the slowest pace in three years. US purchasing managers voiced concerns in the survey about the effect of trade tariffs, the tight labour market and the uncertain direction of the economy. While the decline came after the previous month’s relatively strong data, the initial market reaction was negative with the figures seen as confirming recession concerns.

What is next?

Will these numbers convince the Federal Reserve to cut rates for the third time this year? In Europe, will the falling PMIs (finally) tip the balance towards fiscal support for growth and inflation on top of additional central bank action? For now, we believe in the resilience of the US economy and do not anticipate a recession, but for the eurozone, things look less rosy. The manufacturing recession in Germany might become Europe-wide and the gloom could envelop consumers. A knock to their confidence could weaken their willingness to spend and to keep growth in the green.

Exhibit 2: Eurozone growth forecasts dragged down by Germany and ItalyExhibit 2: Eurozone growth forecasts dragged down by DE and IT

Data as of 30/9/2019. No assurance can be given that any forecast, target or opinion will materialise. Source: Bloomberg, BNP Paribas Asset Management

Any comfort? Recent US employment data was still good, and we may yet get a deal between the US and China with the Trump administration focused on re-election and China concerned about weak economic data such as industrial production.

Investors should remember that modest index returns could well hide opportunities at the industry and stock levels. Measured by the median P/E of stocks in the main index, US equities appear cheaper than they have in years. There is a wider dispersion between the more expensive and cheaper parts of the market than there has been in 17 years. Europe shows a similarly wide gap. So even with flat prices and modest earnings momentum, there are still opportunities to be found [3].


[1] The services powerhouse: Increasingly vital to world economic growth  https://www2.deloitte.com/us/en/insights/economy/issues-by-the-numbers/trade-in-services-economy-growth.html

[2] Chart of the week – Ah appearances https://investors-corner.bnpparibas-am.com/investment-themes/chart-appearances-us-data/

[3] Chart of the week – Looking below the index: industry earnings and valuations https://investors-corner.bnpparibas-am.com/investment-themes/chart-week-index-earnings/


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Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients.

 

Daniel Morris

Senior investment strategist, CFA charterholder

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