Some export-driven countries in the I Fund have been hit the hardest by a manufacturing slowdown. Investors should remain diversified and ensure portfolio risk is in line with their goals and personal situation.

Lyn Alden

The narrative in the financial media throughout 2018 and 2019 has been about a slowing global economy, while 2017 was praised as a year of global synchronized growth.

The trade dispute between the United States and China continues to weigh on global trade, has created uncertainty for supply chains, and may be delaying capital spending. The International Monetary Fund (IMF) already cut its global GDP growth forecast to 3.3% in 2019 due to the trade disputes, and recently put out a note saying that if the trade dispute escalates further, it could cut 0.5% away from global GDP in 2020, which amounts to $455 billion.


Chart Source: International Monetary Fund

As the chart above shows, the negative effect on China is expected from many analysts, including the IMF in this case, to be bigger than on the United States in the near term. China currently has a very high level of corporate leverage throughout its economy, and several politicians and analysts believe this period of vulnerability may be ideal for bringing about change in some of China’s unfair policies, including theft of intellectual property.

From an investor perspective, the trade dispute impacts other countries as well. This chart, using data from the World Bank, shows exports of good and services as a percentage of GDP for the United States and the six largest components of the I Fund:

Chart Source: Lyn Alden, Data from World Bank

As you can see, the United States is somewhat insulated compared to the major I Fund countries, as exports of goods and services account for only 12% of U.S. GDP. Large U.S. companies in the C Fund, however, are more globalized and get well over 40% of their revenue from overseas, according to S&P Dow Jones Indices.

France and the UK have goods/service exports totaling over 30% of GDP, and Germany and Switzerland have among the highest ratios in the world for this metric at 47% and 65% respectively. If China’s economy slows down, or if the U.S. economy slows down, these countries are impacted as well because demand for their exports may decrease.

Out of all these countries, Germany is currently being struck the hardest. Although their exports as a percentage of GDP are only the second highest on the list, they are heavily focused on the automotive industry which is more cyclical than many other manufacturing industries, and currently is in a global downtrend. Therefore, although German official unemployment is very low at just 3.2% (lower than in the United States), their manufacturing purchasing manager’s index has recently fallen to a level of contraction not seen in seven years:


Chart Source: Trading Economics

The manufacturing Purchasing Manager’s Index (PMI) is based on surveys of supply chain managers and is a strong indictor for whether the manufacturing sector of a country is expanding or contracting. When it is over 50 it is likely expanding, and when it is under 50 it is likely contracting.

The United States’ manufacturing PMI recently fell from a high of over 56 in early 2018 to just a slight bit over 50 last month, signaling that it is at risk of a contraction but not quite in one. The UK’s manufacturing PMI fell from over 58 in 2017 down to a little over 49 last month, indicating that it may be in a mild contraction now. France’s was also at 58 and has been hovering between 49 and 51 in recent months. Italy’s fell from 59 to 47, but has since recovered back up to 49. Japan’s PMI volatility has been the least; they hit a high of just 55 in early 2018 and have fallen to just under 50 since then. Australia’s peaked at 62, fell to 50, and has bounced up to around 52. These countries all have borderline manufacturing sectors at the moment; they have fallen significantly from their recent highs but are not yet in a strong contraction by this metric.

For the countries with the biggest focus on exports, Switzerland’s manufacturing PMI fell from 65 in early 2018 down to a little over 48 last month, and Germany’s fell from 63 to 44, which makes it one of the lowest in the world and in a significant contraction. In this case, their large export exposure was a blessing in late 2017 and early 2018 after the global economy enjoyed strong growth throughout 2017, but has become a curse in 2018 and 2019 as the global economy has slowed.

Priced in

The market has taken a lot of this into account, and has priced the equity markets of many of these countries at rather low levels. Companies in the C Fund have an average price-to-earnings ratio of 20 and an average price-to-book ratio of 3.2. Meanwhile, companies in the I Fund have an average price-to-earnings ratio of 15 and an average price-to-book ratio of just 1.6. When sector concentrations are taken into account (e.g. the United States has more technology exposure than Europe, and technology companies tend to trade at higher valuations), this valuation gap between the C Fund and I Fund narrows but does not disappear.

In conclusion, there has been a big negative shift in manufacturing fundamentals over the past 18 months for the United States and the rest of the world, with certain export-driven countries in the I Fund being hit the hardest. Investors would do well to remain diversified and ensure that their level of portfolio risk is in line with their goals and personal situation.