False start

Economic research October 2015

Despite global growth scares and emerging-market woes, the outlook for the global economy and risk assets is promising, says Stewart Robertson.

We continue to believe the world economic outlook is broadly favourable and that the recovery is unlikely to be derailed by what appears to have been a fairly abrupt slowdown in China.

Economic update and outlook

Find out whether the global economy is on the cusp of another recession or is ready to shrug off a sharp  slowdown in China and which asset classes are likely to outperform in coming  months. Watch one of our senior economists, Stewart Robertson, outline why the US central bank should start hiking US interest rates sooner rather than later. He  believes such action would be another signal that the health has returned to the world’s largest economy and answer calls from many other policymakers to remove some uncertainty.  

While Stewart believes financial markets could respond favourably to the Fed taking decisive action and raising rates, markets are likely to suffer more bouts of heightened volatility. Indeed, it could remain an extremely challenging period  in which to preserve capital and generate positive returns. Furthermore, Stewart expects interest rates to stay historically low for some time yet.

Healthy US economy belies fears over rate rise

Although the US central bank said its recent decision to refrain from raising interest rates was in large measure down to concern over the international economic environment, we don’t believe these worries will persist for long. Ultimately the US economy remains in a quite healthy shape: consumers are spending, the housing market is doing well, the labour market is bubbling and unemployment is very low – close to rates that in the past have been followed by rising wage inflation.

It is far too early to suggest any form of inflationary overheating is imminent, but wages are drifting up gently now and as the US Federal Reserve (Fed) is well aware, if you let the inflation genie out of the bottle, it is devilishly difficult to get it back in again. Why take the risk? If a quarter-point rise in interest rates is sufficient to derail the US and global recoveries, then we really are in trouble.

As such we expect interest rates to rise by early next year at the latest. By all means send the message – as the Fed has – that interest rates are likely to go up very slowly and to a level materially lower than those which prevailed in the past. But don’t fall at the first hurdle. Or, having already done so, be more determined to clear it next time.

Whether it is this year or early next, it is entirely appropriate for US interest rates to rise. The economy is resilient enough to withstand modest rate rises and to do so now – or soon at least – sends the message that the economy is reviving and that normality is slowly returning. It is a sign things are getting better, not worse and would, we believe, be reasonably well received by financial markets. One of the clearest indications that it would be the right thing to do is that many within emerging nations have been urging the Fed to get on with it. This is not turkeys voting for Christmas; this is a key part of the world saying that the ground has been laid – it is time to be brave and do the right thing.

Chinese slowdown fears overstated

As for China, it is clear the economy is cooling and will cool further in coming years. But worries about a rapid slowdown are overstated. We do not believe China’s pace of economic growth has slowed to five per cent or worse already, as some of the gloomier pundits would have us believe. Given its size, we should always be concerned about what is happening in China. Unlike some other issues – such as a potential Greek debt default or Russian invasion of the Ukraine – it is unlikely ever to disappear totally from our radar. And that is perfectly appropriate. We should certainly not get complacent about Chinese prospects or economic developments more generally. But neither should we panic unnecessarily.

Volatility surge masks appeal of risk assets

As always, volatile periods within financial markets generate both threats and opportunities. Some of the wilder gyrations that we have seen in 2015 have been unwelcome and potentially destabilizing in their own right. It has been an extremely challenging investment environment in which both to preserve capital and generate positive returns. Although we believe that they should rise slowly in some countries, interest rates are set to stay historically low for many years yet.

As such, the outlook for riskier assets in general and shares in particular, remains moderately favourable. We favour Japanese and European shares. These markets will continue to be supported by the actions of the Bank of Japan and the European Central Bank respectively. US stocks look relatively more expensive given the outlook for US interest rates and the strength of the dollar. Emerging-market equities remain vulnerable, although given the severity of the sell-off already seen pockets of value are starting to emerge.

We are reasonably upbeat on prospects for corporate bonds with companies’ balance sheets in healthy shape and defaults low. But, prospects for government bonds are not encouraging with yields even more unattractive as expectations of a US rate rise lengthen.

We are enthusiastic on prospects for real estate with yields likely to remain attractive compared with other asset classes for some time yet.

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