Improved Growth in a Diverging World

IMPROVED GROWTH IN A DIVERGING WORLD

The global economy is still struggling to gain momentum as many high-income countries continue to grapple with legacies of the global financial crisis and emerging economies are less dynamic than in the past.

Global growth in 2014 was lower than initially expected, continuing a pattern of disappointing figures over the past several years.  Growth picked up only marginally in 2014, to 2.6 percent, from 2.5 percent in 2013.  Beneath these headline numbers, increasingly divergent trends are at work in major economies.

Barring major geopolitical upheaval, global economic growth in 2015 will hold at a rate close to 3 percent, we believe.  The U.S will continue to grow but the expansionary phase will show signs of maturing, causing a moderation in company profitability, joined by a variety of cost pressures.  The Eurozone continues to flounder, with significant weakness in the large economies of Germany, France and Italy.  True, European economies may have more scope to recover but there are dark clouds—from slowing exports to emerging markets, especially hurting Germany’s growth engine, and a dysfunctional policy environment to tackle the serious deflationary pressures, which have emerged.  Then there is Greece!

UK – POLITICAL PARTIES FIRE MAY 2015 ELECTION GUN

The U.K’s economic growth slowed more than expected in the final three months of last year but with annual growth still at its fastest since 2007, the data gives ammunition to both sides of the political divide heading into May's General Election.  Growth in the third quarter fell to 0.5 percent from 0.7 percent in the third.  But for the year as a whole, the economy grew by 2.6 percent, the Office for National Statistics (ONS) said, up from 1.7 percent in 2013 and putting it on track to have been the world's fastest-growing major advanced economy last year, though some may point to imbalances within the data (See Fig. 1).

While most countries have not yet reported 2014 growth data, Britain's is ahead of International Monetary Fund estimates for other big developed nations, a fillip for the Conservatives and PM David Cameron, who faces the General Election on May 7.  Oppositions, on the other hand, who form governments also need momentum, a dominance over the field of debate - and luck.  Napoleon, it is said, wanted lucky generals.  Now Ed Miliband’s troops wonder whether their commander breaks too many mirrors.  For four and a half years, the Labour leader has set out the case to rewire the British economy to make average earners better off.  Oppositions pray for bad news, and a run of positive economic data, the Tories say, has holed their case for radical change below the waterline.  Therefore, despite the polls being largely neck and neck between Labour and Conservative, a number ask whether Ed Miliband is an unlucky general? A slew of positive economic data certainly gives Ed Miliband an upwards struggle, we feel.

PROSPECTS FOR THE GLOBAL ECONOMY – A COMPLICATED MOSAIC

One of the most significant Economic factors of recent times has been the worldwide benefit of the “plunge” in oil prices, which have more than halved since last June.  But this large positive, is also being increasingly offset by adverse factors.  For instance, the IMF, in its most recent report, (Jan 20), cites weaker prospects for China, Russia, the Eurozone and Japan as well as a slowdown in some major oil exporters because of the sharp drop in crude prices.  New factors supporting growth – lower oil prices, but also depreciation of euro and yen – are increasingly being offset by persistent negative forces, including the lingering legacies of the financial crisis and lower potential growth in many countries – e.g.  Russia is now viewed as being in outright recession this year, as falling oil prices and sanctions imposed by western governments take their toll.  Japan is also in recession and China slowing down.

This certainly makes for a complicated mosaic...  good news for oil importers, bad news for oil exporters.  Good news for commodity importers, bad news for exporters.  Continuing struggles for the countries which show scars of the crisis, and not so for others.  Good news for countries more linked to the euro and the yen, bad news for those more linked to the dollar.

The UK is expected to lose its place as the fastest-growing major economy to the US this year, with UK growth forecast at 2.7% and the US at 3.6%. For the Eurozone, though, we may expect a drag from weaker investment prospects, particularly thanks to a knock-on effect on exporters from an emerging markets slowdown. That is predicted to offset support from lower oil prices, the recent euro depreciation, an easing in austerity programmes and more monetary policy support, which has just been unveiled after the European Central Bank’s (ECB) latest meeting. This support comes in the form of a €60bn-a-month Quantitative Easing (QE) for the Eurozone, starting in March and continuing for 19 months, which may be regarded as an imperfect compromise but by protecting itself from losses, the ECB recognises the possibility of European sovereign default. Essentially, it is a commitment to flood the Eurozone with more than €1 trillion ($1.16 trillion) in newly created money. What it does is create a new stimulus to strengthen demand, increase capacity utilization and support money and credit growth. Such a vast expansion of the ECB’s easy-money policies would traditionally stoke inflation down the road but it must be noted that inflation has stayed very low even after several interest-rate cuts and abundant ECB loans to banks. We have seen QE in the U.S. and Japan, but we believe its success is also dependent upon structural reform. Without that it may not work and, frankly, we see little sign (of structural reform) in key countries like France and Italy.

US: MODERATELY POSITIVE

• US growth will grow at a modest 2.6 percent in 2015.
• Profitability may come under increased pressure as the business cycle matures and cost increases are imminent.
• America’s strength in technological progress needs to help accelerate productivity.

UK: A POSITION OF RELATIVE STRENGTH

·         Despite positive economic figures, significant longer term challenges stemming from the country’s fiscal situation do remain.

·         Political uncertainty – multi party politics and unknown Coalition deals?

EURO-AREA: CAUTIOUS; DOWNSIDE RISKS ACCUMULATE

• Despite significant downside risks, the Euro Area is projected to grow at 1.6 percent in 2015, almost double that of 2014.
• Modest recovery in domestic consumption is a likely source of growth as labour markets improve.
• However, deflation has arrived and could yet bring growth rates down further.
• The Greece burden – see Special Feature below.

ASIA-PACIFIC: CHALLENGING IN CHINA; MOSTLY POSITIVE ELSEWHERE

• Despite softening growth rates, the Asia-Pacific region remains the leader for global growth.
• Growth rates of China and India are converging to 5.5 percent from 2015–2019.
• Despite short-term headwinds from the global economy, Southeast Asia will strengthen.

LATIN AMERICA: UPSIDE POTENTIAL

• Economic conditions in Latin America are unlikely to improve rapidly in 2015, with regional growth at only 1.8 percent.
• Slowing prices for commodity and energy exports provide significant downside.
• Productivity growth should build on investment, improved business confidence, and a better educated labour force.

A SPECIAL FEATURE: THE IMPORTANCE OF GREECE AND WHERE THE EUROZONE GOES FROM HERE?

Syriza's election victory raises some difficult questions for the other countries using the currency and for the European institutions.

The party's proposals represent a challenge to the austerity that has been a central feature of the Eurozone’s response to the financial crisis - bailout loans combined with spending cuts and tax rises to reduce borrowing needs and economic reforms to encourage growth.

For the architects of that response - especially the European Commission and Germany - the idea of renegotiating the terms and reducing the debt is an unpalatable one.

Germany and some other Eurozone countries already have political problems with the bailouts - received by a total of five countries.  Many voters resented the financial assistance, even though it was loans.  Any suggestion that they won't be repaid in full will aggravate those concerns.

The key to the Greek burden does lie with the Eurozone and its taxpayers.  And, the inevitable question?

After Greece, Spain?

There is a fudge that could be used to ease the Greek debt burden, and it has already been used.  That is to reduce the interest rate on its debts to the Eurozone and extend the repayment period without actually cutting the nominal value of the debt to be repaid and the odds are that some sort of compromise will emerge.  Yet, to give ground to Syriza could also be read as suggesting that the austerity approach was a fundamental mistake.  After all many economists argued that cutting government spending and raising taxes was exactly the wrong thing to do in economies that were already weak.  Austerity aggravated the weakness, they argued, and so undermined tax revenue and exacerbated the government financial problems it was supposed to fix.

Another problem for Germany and those that share its view is that concessions to Syriza might embolden anti-austerity political forces in other countries.

Spain's Podemos party is a striking recent arrival on the political scene, but others will also be watching developments in Greece very closely.  But even if the eurozone can keep the lid on any financial market fears of a wider break-up, the possibility of Greece leaving can't be discounted.

The Syriza leader Alexis Tsipras says he doesn't want it and nor does Greek public opinion.  Even Germany doesn't want it, though there is a limit to the concessions that Chancellor Angela Merkel and her Finance Minister Wolfgang Schaeuble are likely to make.

So the odds are that some sort of compromise will emerge.  It may well be messy and be slow to take shape.  But then did the Eurozone ever do anything that's difficult quickly or easily?

MARKET OUTLOOK: STILL GO GLOBAL AND MANAGE RISK BY ASSET ALLOCATION

As demonstrated by the returns over past decades, and as said before, choosing a strong approach to managing assets can make a big difference to a portfolio.  Avoiding common mistakes, such as emotional decision making, only focusing on traditional asset classes, and not having a risk management plan, is important.  Often investors don’t have the time or the patience to manage their assets effectively.  Maintain decent UK exposure but consider, as well, foreign market exposure.  Within equities, consider a value approach.  Within and across asset classes, consider using trend following methods and diversity to reduce risk and exposure to catastrophic loss.

Geopolitical tensions and any disappointment on corporate earnings will create dips but we still regard any such dips as an opportunity for selective buying opportunities.  Many analysts believe the oil price needs to trade around $40 a barrel to slow supply growth and keep capital investment in shale sidelined.  High quality global journalism requires investment.  But most importantly there is no sign of Opec, or its de facto leader Saudi Arabia, changing policy and lowering its production target of 30m barrels a day.  Indeed, Mr Badri said last week that Opec was “not the cause” of the supply glut “so we are not cutting”.

Sources

·         Office For National Statistics (ONS) January and February 2015 Economic Reviews

·         The Wall Street Journal,  22 Jan 2015

·         BBC News Business, Robert Peston Blog, 20 Jan 2015

·         IMF You Tube Video Release – 22 Jan update of the World Economic Outlook, Chief Economist Olivier Blanchard

·         Financial Times – Global Economy comment and review, Background Research Jan / Feb 2015

The above is our opinion but it is no guarantee of future performance.  The above information should also not be solely relied upon for investment purposes.  We seek a balanced portfolio and reiterate the preference for putting in place a balanced portfolio of investments, made up of collective investments.  As you are aware, there are many ways to invest in equities.  Each has its own practical and taxation considerations and, for this purpose, collective investments, such as unit trusts, are an appropriate means by which a good spread of investments may be achieved.  Such pooled funds put the fund in a position to hold a good spread of company shares.  The funds are managed on a day-to-day basis by professional investment managers to try and achieve the best possible returns.  They represent the best means of managing the risks by asset allocation.  The value of investments and any income will fluctuate (this may partly be the result of exchange rate fluctuations) and investors may not get back the full amount invested.  Past performance is not a guide to future returns.  Current tax levels and reliefs may change.  Depending on individual circumstances, this may affect investment returns.

SJK 02.02.15