"On balance, we expect ongoing growth around the globe, but at a disappointing rate," is the way that Robeco Chief Strategist Ronald Doeswijk sums up the global macroeconomic picture at the moment.
There have certainly been some encouraging developments recently. Take the US. The rise in the purchasing managers’ index for manufacturers in February confirmed that the underlying momentum in the economy is picking up.
“Signs of continuing improvement convince us that the recovery will remain on track"
Japan’s politicians are getting their act together
In Japan, meanwhile, politicians are operating more vigorously to crank up the country’s sclerotic economy. One example of this move up through the gears is the nomination of the dovish Haruhiko Kuroda as the new governor of the Bank of Japan, a step that takes Japan closer to more aggressive monetary easing. At the same time, the latest data on the Japanese recovery has been encouraging; industrial production rose by 1.0% in January.
Even the eurozone economy is showing signs of stabilization, as evidenced by net deposit inflows in Spain. And monetary policy around the globe is set to remain loose.
So far, so good. But there have also been some less positive developments, which are responsible for the cautious note in Doeswijk’s summing up.
US sequestration worries should fade
In the US, sequestration—automatic federal spending cuts worth USD 85 billion over the next six months—kicked in on March 1. This has the potential to suppress US economic activity in the coming months.
But Doeswijk doesn’t see this as too big a worry, as a deal will probably be forged at some stage.
“We expect this ripple to fade rather than becoming a threat to the recovery”
The severity of Italy’s situation is being underestimated
The other main concern is the heightened political risk in the eurozone after the unexpected stalemate in February’s Italian elections. “The strong performance of anti-austerity factions could destabilize the eurozone and undermine growth,” cautions Doeswijk.
Markets have reacted relatively calmly to Italy’s political developments, apparently comforted by the ECB’s backstop, the OMT. But there is a catch: an ECB activation of the OMT would have to be preceded by the introduction of a reform program in Italy agreed with the EU and the IMF that would be monitored by the troika.
It is fair to say that in the current political environment, the introduction of a comprehensive reform/austerity program looks pretty unlikely. The credibility of the conditionality of the OMT program demanded by the ECB could thus be tested.
Doeswijk thinks the situation could easily deteriorate. “Markets are probably too complacent about the Italian situation,” he warns. “A flare-up of the European debt crisis in the coming months is a serious possibility.”
Positive on equities
So how does this moderately improving macro picture feed through into asset-allocation positioning? Doeswijk and his Financial Markets Research team colleagues are relatively upbeat on equities.
“We believe stock prices will trend higher”
For sure, there are risks to this picture. First, increased tensions within the eurozone after the Italian election could turn sentiment negative. Second, it could transpire that the conditionality of the ECB’s support really is conditional.
But Doeswijk feels that more positive forces will prevail. “We maintain our view that quantitative easing and low interest rates are the dominant forces at work for the time being,” he says.
North America is the preferred region in equities
Within equities, North America is the team’s favorite region. This is largely down to the macro picture, in particular the self-reinforcing economic recovery in the US. “Given the fiscal headwinds, we expect monetary easing to continue for the foreseeable future, while producer confidence, the housing market and the labor market are all pointing to ongoing growth,” says Doeswijk.
“Government bonds are the least attractive asset category”
Emerging markets are neutral. Economic data there has tended to disappoint, a period of relatively good earnings revisions appears to be over and momentum is disappointing. “The region’s good medium- to long-term prospects are unlikely to play a major role in short-term performance,” cautions Doeswijk.
Prospects for Pacific equities have improved
The outlook for the Pacific has brightened, thanks to the efforts of Japan’s prime minister to drive forward aggressive monetary easing, economic reform and fiscal stimulus. Moreover, the weakening yen should boost Japanese exports. The team has a neutral stance on the region for now. “We want to see proof that this policy change will benefit Japan,” he says.
As for Europe, the team maintains its “somewhat negative” view, thanks to the risk of ongoing economic disappointments due to austerity and uncertainty among producers and consumers. “Earnings revisions continue to lag the market,” adds Doeswijk.
High yield and emerging markets favored
The Financial Markets Research team continues to like the prospects for corporate bonds. Why so? “Moderate economic growth is the best possible macroeconomic environment for corporate bonds,” says Doeswijk. That is because it results in low default rates and prevents a wave of aggressive takeovers or leveraged buy-outs.
And while both investment-grade credits and high yield bonds are attractive relative to cash or government bonds, they do have a clear preference for high yield. “Our preference is mostly based on the higher running yield, which still leaves room for attractive absolute returns,” explains Doeswijk.
The team also likes emerging markets debt. The asset category is experiencing solid net inflows, which highlights the popularity of emerging debt as the search for yield continues.
Negative on government bonds
Doeswijk and colleagues thus favor all three types of bonds to developed-market government bonds. “Although we are not forecasting a significant rise in bond yields, we rank government bonds as the least attractive asset category,” says Doeswijk. “The current low yields are not offering the opportunity for decent returns.”
Real estate prospects attractive despite valuation
The outlook for real estate remains good: the team ranks its prospects in line with those of equities. After a disappointing January, real estate was the best-performing asset class in February. Ten-year bond yields have fallen a little, while other positive factors remain in play. But there is one worry that holds Doeswijk back from positioning real estate above equities: valuation relative to equities is unattractive.
Neutral on commodities
On commodities, the team has a neutral stance. “Oil price fundamentals point to an oil market that is balanced,” says Doeswijk. On the supply side, lower OPEC production is being offset by record US output. And increased demand from the strengthening US and Chinese economies will probably more than compensate for the falling demand from Europe.
Although gold prices have dipped recently, Doeswijk says it is too early to call the start of a bear market. The close relationship between the price of gold and the expansion of the Fed’s balance sheet has fractured recently, thanks to more bearish Fed minutes that hinted at a cessation of that enlargement. But Ben Bernanke’s more recent indications that the US central bank will continue to pump up its balance sheet suggest a negative call on gold would be premature.