Economic Outlook August 2014

After a month of falling equity prices, widening yield spreads, and higher volatility, markets calmed down in August. Economic news was on aggregate disappointing in Europe, but proved sound in the US. Optimism remained in emerging markets.

In the US the S&P 500 returned 4.0% in August, while Europe rose about 1.8%, both in local currency. In Japan the Nikkei 225 fell 1.25% during the month. In Asia ex. Japan and the Nordic equity investors saw a return of 0,40% and 0,70% respectively. The VIX also had a volatile month with a peak around 17.5 in the beginning of August, and ended around 12. High yield spreads in the US also tightened after having increased as much as 150 basis points during the summer.

In the US most indicators continue to show that the economic downturn we saw in the first quarter was due to temporary factors, mainly a very cold winter and de-stocking in the automotive sector. Since then the labor market, housing market, industrial production, PMIs, ISM etc. have given us good signs of a sound recovery. SEB estimate GDP growth of 3.4% and 3.1% pa in 2015 and 2016 respectively. There is still spare capacity in the economy so we foresee no dramatic rate hike from the extreme low levels we currently see. We predict the first rate hike to take place in April 2015. The 10 year government bond is down about 60 basis points in 2014 to about 2.35%. We see it as probable that it will rise to 3.2% by the end of 2015, and recommend investors to be careful investing in US government bonds. As the US economy are among the strongest, and will be early in the rate hiking cycle we also expect the USD to appreciate against most major currencies over the next year.

In Europe the picture is somewhat different. European countries have been slower than the US to cut cost, reform the economy and strengthening their banks. In addition, the ongoing tensions in Ukraine have not made the situation any easier.  Even though the direct economic impact from the dispute with Russia over Ukraine is small, it does something with sentiment of investors, consumers and companies. Germany has kept up nicely so far, but is now feeling headwinds. After a very solid GDP growth of 0.7% in the first quarter, the second quarter growth came in at -0.2% and weaker than the -0.1% consensus expectations. Even though the hard numbers in Europe have disappointed of late, we are of the opinion that it is temporary, and that economic activity gradually will return. As we expect a slow economic recovery in Europe, the return to a more normal monetary policy will also be slower, and we do not see the ECB hiking interest rate any time soon. Rather, we expect the bank to prepare for quantitative easing (QE) in the first quarter next year. The 10 year government bond yield in Germany has fallen about 1% in 2014, to under 1%. SEB predicts it to be 1.50% by the end of 2015, thus we recommend investors to look for other investment opportunities. With government bond yield spreads between US and Europe to widen, weaker economic growth and stimulating monetary policy in Europe, we expect a relatively weak Euro in the foreseeable future.

The Chinese economy seems to be holding up well against the ongoing downturn in the construction sector. SEB has revised our GDP growth forecast upward to 7.5% in 2014, and 7.3% in 2015. After that we foresee a controlled and cautious slowdown to 6.9% in 2016.

In the aftermath of the election in India investors have raised their hopes for needed economic reforms in India. We are worried that reforms are more complicated to implement, but still predict economic growth of around 5% and 6% for 2015 and 2016 respectively. Brazil has a presidential election coming up in October. Structural reforms are essential if the economy is to gain momentum, and increase growth from our forecast of 1% for 2014.

Going forward we expect investors to gradually put on more risk. With government and corporate bond yields at low levels we see few other options than equities. Our favored regions are Europe and Asia. Even though Europe has been slow to reform, we do see that opportunities lie ahead.  Asia ex Japan is, together with the US, the growth engine of the world. With their dynamic economies and willingness to adopt, we think Asia will lead the way with China as the leading star. Thus the region is our most favored in the emerging world. 

By Hans Kristian Hals, Head of Investment Strategy