2013 is not quite turning out as predicted. The tremendous rally in markets since summer 2012 – undeniably led by European Central Bank president Draghi’s pledge to preserve the euro and the move towards potentially unlimited quantitative easing in the US – appears to be grinding to a halt. Economists had been widely predicting a raft of soft data globally into the second quarter of this year, but instead macroeconomic releases have generally been brighter than anticipated, particularly in the US. But the prospect of the return to a more normal environment, one in which policy begins to take a back-seat to growth, has not been well-received by markets addicted to stimulus. The US Federal Reserve (Fed) has been talking in more definitive terms about an exit strategy from unconventional monetary policy. At its meeting in June it said that it could begin tapering its asset purchases later this year and potentially end them by mid-
2014. Volatility returned to markets globally during what became a broad sell-off that has encompassed both equities and bonds. The withdrawal of US ‘easy money’ is something that the world fears – not simply because of the risk of a policy error, but because a return to fundamental-based investing will have to occur if it does work – something that could greatly affect areas of the capital market that have seen substantial inflows, such as emerging market (EM) debt.
The pace of economic recovery will be inconsistent across economies globally, so greater care will have to be taken with asset allocation decisions.
The long march
We are positive about the US, which remains one of our overweights. It arguably led the way into the financial crisis and it now appears to be leading the way out. The widely predicted soft patch in US growth has not manifested itself as dramatically as analysts thought it would. Despite the fiscal drag from the increase in payroll tax and the automatic spending cuts of the budget ‘sequester’, first quarter US GDP growth at 1.8% (quarter-on-quarter, annualised) is, we feel, a respectable result. There are several indicators that suggest that the US private sector recovery could become more visible in the second half of the year (chart 1). The keenly-watched non-farm payrolls employment report continues to show steady job creation. Adding further cause for optimism, the weakness seen in oil & gasoline prices should be putting money in Americans’ pockets at the same time that rising house prices are boosting consumer confidence. Taking these factors into consideration, the fact that the US Fed is talking in more certain terms about tapering its asset purchases should not come as too much of a shock. For our own part, we expect the march back to normality will be a gradual process rather than a sudden event, and we continue to believe the Fed will more likely err on the side of caution. In the meantime market volatility is likely to persist until investors feel more comfortable about the balance between policy and growth.
Chart 1: Recovery underway in US housing and autos
We are also currently overweight Japan, which we believe could be one of the brighter spots within the global economy. The country is experiencing a dramatic change in policy regime, with two of the government’s three ‘arrows’ for growth already in flight: hyper easy monetary policy and increased government spending. Early this year, the BoJ adopted a 2% inflation target and introduced an open-ended asset purchase plan, later pledging to double the Japanese monetary base over two years. The hope here is that the scale of the intervention will break the deflationary mentality that has prevailed in Japan since the advent of the ‘lost decade’. We can probably expect these bold measures to continue – including more related to the third policy ‘arrow’ of longer-term structural reforms. Mr Abe has just outlined a series of goals, which he hopes will lift Japan’s growth rate to 3% by 2020. These include increasing private-sector investment, infrastructure expenditure, encouraging more women into work, and deregulation of goods, capital and labour markets.
There is already some evidence that Mr Abe’s policies are gaining traction in the economy: Japanese GDP growth’s surge to 4.1% (annualised) in the first quarter and the consumer prices index moving out of negative territory for the first time in seven months in May together suggest that ‘Abenomics’ is having the desired impact.
Consumer and business confidence has been improving and the country is also beginning to see upgrades to company earnings forecasts. That said, the recent jump in government bond yields and equity market volatility has raised some doubts about the efficacy and sustainability of the policy shift. Investors are likely to remain sensitive to these issues and will require reassurances that policy changes will be managed carefully.
Opinion column by Bill McQuaker, Deputy Head of Equities for Henderson Global Investors.