Without doubt, the most significant economic development of 2013 has been the transformation of economic policy in Japan. The authorities have planned a massive monetary injection, combined with a fiscal stimulus and other reforms to encourage growth. Unlike previous attempts by the Japanese to fight their way out of deflation, the size of the package and the determined manner in which it has been implemented, has surprised nearly all observers.
There are clearly still difficult structural issues, which haven’t gone away but the effects of the package, combined with a much weaker yen and the consumption tax that is expected next year, which should bring forward expenditure, could be significant. We forecast 1.5% GDP this year and next, both a little above consensus forecasts.
In the US, we see reasonable growth ahead, despite the tightening of fiscal policy, as the economy appears to have built up useful momentum. Following recent revisions, it appears that employment has shown steady growth this year and the housing market continues to display a healthy recovery. We are looking for 2.0% GDP in 2013 and a further pick-up to 2.5% in 2014.
Eurozone economic activity remains very weak due to fiscal austerity and credit constraints. The recent softening of French activity is an increasing concern, and shows that the region’s problems are not confined to the periphery. Germany is also proving less of a positive factor than was previously the case, and is suffering from euro appreciation against some important competitors. We expect a fall in eurozone GDP of 0.5% in the current year, followed by some recovery to 0.5% growth in 2014. The UK just managed to achieve positive growth in Q1 and we retain our forecast for a 1.0% increase in GDP for the year as a whole. The weak eurozone has hit the UK’s trade balance, but a moderately surprising level of employment growth, a fall in oil prices and the Chancellor’s budget stimulus to the housing market should help consumption. We look for expansion next year of 1.5%.
Our forecasts for a pedestrian global economic recovery lead us to favor quality companies, with good dividend yields, in the more defensive areas. This strategy has been successful and consequently businesses with these profiles have become fairly expensively rated relative to other areas. We continue to favor this broad stance, but we have looked selectively to add to some of the more cyclical stocks, which have underperformed, as we seek value.
Equity markets have continued to show resilience despite a mediocre corporate reporting season and slow economies. We believe this is due to markets continuing to display relatively attractive levels of valuations and on account of the impact of global quantitative easing. This makes low risk investments increasingly unattractive and pushes liquidity into other assets. While valuations remain satisfactory, economies show some recovery and easy money continues, we believe it is right to remain above benchmark in equities.
Government bonds on the other hand have moved to unattractive yields and we have underweight holdings. At some point, yields will rise but it may not be imminent as central banks will endeavor to keep yields low to encourage growth. We continue to see better value in corporate and emerging market debt. These asset classes are enjoying healthy fundamentals and buoyant inflows, as investors search for higher yields.