House view Q3 2014
As the global recovery gathers pace, markets have underestimated the willingness of central banks to support growth with accommodative policy.
- Upbeat on US and Japanese equity prospects as global recovery persists.
- Deflation risk to force ECB to launch QE sooner than many expect in 2015, fuelling demand for Eurozone assets.
- Japanese monetary policy to remain accommodative longer than market expects, buoying domestic equities.
Markets staying upbeat
The global economy is likely to achieve encouraging growth levels this year, despite the tapering of the US central bank’s asset purchase programme. Geopolitical tensions in Ukraine, the Middle East and elsewhere seem to have been largely ignored by markets, which seem upbeat on global economic growth prospects. So we forecast global annualised growth of 3% to 4% this year, in line with consensus1. At the same time, we expect inflationary pressures in the US, Japanese, European and the UK economies to remain moderate, with monetary policy looser for longer than many expect.
In our view, annualised global growth of around 3.5% between 2015 and 2017 is largely in line with consensus. At the same time, some of our growth forecasts among the largest economies differ markedly from market expectations. We believe the market has not fully priced in the potential impacts of the surprise contraction of 2.9% in the first quarter.
US holding steady
This may mask more fundamental weakness in the US economy that hits growth later in the year. Despite some weakness, we still expect US annualised growth to average around 3% over the three years to 2017, supported by increased household wealth, a stronger housing market and higher employment numbers.
The Japanese economy continues to respond well to the radical set of economic stimulus measures aimed at lifting growth and inflation – the so-called “Abenomics”. Japan was the fastest expanding developed economy in the first quarter of 2014, with strong growth in consumer spending helping the economy to grow by 4.1% year-on-year during the quarter.
All set to beat expectations
The increased business confidence seen recently could prompt significant increases in business investment over the coming months. In turn, this will help to bolster the outlook for the economy and domestic equities. While the Japanese economy could grow slightly less than market expectations this year, we believe Abenomics will deliver significantly higher growth than forecast in both 2016 and 2017. Even so, monetary policy is likely to remain accommodative over the medium term. This should buoy equity markets and keep the yen relatively weak against the US dollar.
Positioning for growth
With modest global growth and subdued inflation in the short term, we recommend being overweight equities in the multi-asset portfolios. We are upbeat on the prospects for Japanese, US and other developed market equities over the rest of 2014. We are also wary that valuations already largely reflect global growth prospects, so disappointing economic data could spark a market correction. Weak growth and deflation risks in the euro zone are another concern.
Credit markets should be aided by better global growth, although tight spreads my result in lower returns with the risk of brief corrections as carry trades unwind. US interest rates are expected to stay on hold into 2015 (although UK rates could rise sooner), so we believe yields on high-quality sovereigns will remain very low by historical standards this year. Bond returns may struggle as interest rates and yields rise.
While the Japanese economy could grow slightly less than market expectations this year, we believe Abenomics will deliver significantly higher growth than expected
Senior Economist (UK and Europe)
The dollar – safe haven in a storm
We prefer to remain overweight the US dollar, particularly against sterling, which looks the most overvalued major currency. The dollar’s ‘safe-haven’ status means the currency should also provide some downside protection for multi-asset portfolios during periods of heightened market tension.
ECB ignores deflation risk at its peril
The ECB continues to insist that there is no deflation risk and the euro zone is merely experiencing an extended period of low inflation. Worryingly, this is reminiscent of the Japanese authorities’ attitude in the mid-1990s just before the ‘lost decade’. Inflation has been falling since 2011 to 0.5% in June. A series of measures to boost bank lending to business and resuscitate the economy are a drop in the ocean of measures required to resolve the issue.
QE earlier than expected
Despite resistance among many euro zone policy makers to QE, we believe the ECB will launch an asset-purchase programme in the first half of 2015 – earlier than expected. Rate rises in the area look a long way off. QE programmes in the US, Japan and the UK have helped their economies to grow by between seven and 10% since 2009. By contrast, the euro zone economy (excluding Germany) grew by just 0.4% over the same period.
Market reactions to QE
European equities and bonds should react positively to any QE initiative, aided by additional market liquidity. Pairing euro zone equities with long euro bonds is one way to take advantage. We prefer to be slightly overweight fixed-income, especially as we expect rates to stay lower for longer. The search for yield has pushed spreads across a range of euro zone bond and credit markets to multi-year lows. Weak growth and accommodative monetary policy, however, mean there could be further falls.
Emerging markets on the mend
While emerging markets face economic headwinds and the possibility of geopolitical tensions, we are optimistic they will perform better over the second half of 2014. We view emerging markets increasingly as distinct areas rather one bloc or asset class. We are more upbeat on the outlook for Asia and eastern Europe, less so for Latin America.
Emerging markets with below-trend economic growth and inflation, favourable trade links, and low dependence on commodity prices are likely to outperform other their peers. Eastern European countries such as Poland, Hungary, Romania and Turkey particularly fit this profile. Equities in the region offer a play on this theme and should also gain from any European equity rally.
The outlook for Latin America is clouded by this year's election in Brazil. Local-currency bonds in the country, however, offer a particularly attractive yield: downside currency risk has been minimised by significant depreciation in the Brazilian real over the last year.