The slowdown in global growth bears strong resemblance to a 2015-16 episode that was driven in large part by softness in China. This time around, China’s problems could prove even more damaging, warned economists at Oxford Economics.

“The Chinese slowdown could have serious negative consequences for world growth if it intensifies. Our model simulations suggest that world growth could slow to a decade low of 2.3% in 2019 if Chinese growth slows sharply and could drop below 2% in the event of a combined slowdown in China and the U.S.,” wrote Adam Slater and John Payne in a Tuesday note (see chart below).

Oxford Economics

Earnings fallout

The warning comes as investors attempt to parse the drag China’s woes could have on earnings for U.S. corporations as earnings season moves into full swing. Shares of Caterpillar Inc. CAT, -0.96% slumped Monday after the Deerfield, Ill.-based heavy-equipment maker blamed weak demand from China in part for sales that badly missed Wall Street expectations. Caterpillar was the latest of a growing number of industrial companies who have said sales are softening in China.

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Earnings from Apple Inc. AAPL, -3.17% are due after the closing bell. The tech giant roiled markets early this month when it warned it would report much lower sales than previously expected, largely due to slowing iPhone sales and weakness in China.

U.S. stocks sold off sharply in late 2018, leaving the S&P 500 SPX, -1.11% with a calendar-year loss of more than 6% as investors wrestled with a range of worries, including concerns about the pace of the Federal Reserve’s rate increases and China’s slowing economy. Signs the Fed is prepared to slow the pace of monetary tightening and rounds of stimulus measures by Chinese policy makers have helped fuel a January rebound that’s seen the S&P 500 and Dow Jones Industrial Average DJIA, -0.87% each bounce back by more than 5%.

But skeptics question whether the stimulus measures, which echo China’s 2016 policy response, will have the same effect in 2019.

3 dangers

Meanwhile, the economists noted three ways China’s problems can weigh on global growth:

• Weaker domestic demand growth in China cuts imports of final goods (consumer and investment goods) from the rest of the world (ROW).

• Weaker Chinese export growth reduces demand for imports of intermediates and raw materials from ROW, a significant channel given the relatively high import content of Chinese exports.

• Weaker Chinese demand pushes down prices of key global commodities like iron ore and copper, inflicting terms of trade losses on exporters of these products (mostly emerging markets).

“All these channels seem to be operating,” the economists wrote, noting that China’s import volumes fell sharply in late 2018, with some of the biggest falls suffered by the country’s key Asian partners and component suppliers such as Singapore, Korea, Thailand and Taiwan.

China-sensitive commodities are also beginning to feel pressure, they noted, with an index they use to track prices off 11% year-over-year in January after being up 16% year-over-year as recently as May.

And the effects of the U.S.-China trade dispute are becoming visible, with China’s goods imports from the U.S. down 30% year-over-year in December; Chinese exports to the U.S., which had been holding up, are also starting to slip, they said. Moreover, more weakness for China exports appears in the offing, with the Chinese export purchasing managers index, which leads actual exports by around six months, fell in December to its lowest level since mid-2016 (see chart below).

Oxford Economics

Baselines

The economists said their baseline forecast is for Chinese growth to bottom out in the second quarter but not rebound, contributing to world growth of 2.7% in 2019 versus 3% last year. But they warned that a worse outcome is “significant risk.”

The danger is particularly keen for the global industrial sector, they said, with the world manufacturing PMI at 51.5 (a reading of more than 50 signals an expansion in activity), consistent with world growth near the firm’s 2.7% baseline forecast. But the trend in Chinese demand means the indicator could easily slip toward the 2016 low of 50.7, implying world growth of around 2.5%; or even to 48 - 49, implying declining global manufacturing output and consistent with world growth of just 1.9% - 2.1%,” they said.

The economic model used by Oxford Economics suggests a 1 percentage point negative shock to Chinese GDP would cut world GDP by 0.2% in 2019-20. A fall of 2 percentage points in Chinese growth relative to the baseline would cut world growth by around 0.5%, leaving world growth at 2.3%, the slowest since 2009.

And if U.S. and Chinese GDP both fell by 2 percentage points relative to the firm’s baseline forecast, global GDP would suffer a 1.5 percentage point hit, leaving global growth at 1.7% year-over-year in 2019. They noted that with world population growth seen at around 1.1% a year, such an outcome wouldn’t be far off the IMF definition of a global recession.