February showed positive returns for many asset classes. Global equity markets had a positive month in general and most commodity classes generated positive returns. However, industrial metals have lagged the overall commodity mix / index. As such, the start of the year has been somewhat roller-coaster like proved by a risk-off market with equity fund outflows and bond market inflows in January and a risk-on market in favor of equities and commodities in February. As such, we will still characterize the global financial and commodity markets as being in quite a healthy shape, even though we see some signs of weakness in parts of the emerging economy area.
With that said, we still put our attention to the larger economies: China, Europe and the US. They are still the by far most important countries and regions to follow when measuring economic trends and overall direction of the global economy.
The Chinese economy is on a growth path, but there have been some softer indicators during the first two months of the year. We have earlier stated that this will increase the focus on the upcoming Chinese Peoples Party Congress that will take place in March. In relation to this, Chinese officials have communicated that annual 7.5% GDP growth is still the official target. As such, it seems like growth is still a priority over reforms. A contrarian view on this is that the official China is well aware of the fact that reforms are costly and that the country will need to grow to reform. The fact is that if the economy drops, the highly needed reforms will be pushed back. However, one way or the other we will have to see reforms implemented in China. The Chinese economy is artificially stimulated by fiscal programs and overloaded with governmental infrastructure investments. The targeted 7.5% GDP growth will open up for further needed fiscal programs later in 2014. That might be an adequate tool to reach a target, but it leaves an unstable fundament for building a strong long-lasting economy. As such, we follow the Chinese economic outlook closely, aware of the fact that a potential slowdown in China will have almost imminent spill-over effects on global GDP outlook in general. Therefore, export and import data will be crucial to track for the coming months, as these two indicators will show appetite for Chinese goods internationally as well as domestic demand, respectively.
The US economy showed surprisingly slow employment and economic indicator statistics throughout February. Extreme cold and windy weather is said to be the explanation factor for the negative deviations from expectations. Even though we do not doubt that weather extremes might have had impacts, slower US economic growth versus expectations might also be part of the explanation. As such, the jury is still out when it comes to judging the fact: Is the US economic growth (still) in a satisfactory trend or has it started to show early signs of a slowdown? It is too early to conclude on this, however with an overwhelming majority leaning on a belief in the winter-weather explanation story, it might pay off to be contrarian and have a directional bet on a US early-sign slow down.
Japan reported disappointing GDP for Q4 2013 in February, showing unchanged growth from the previous quarter. Japan’s economy grew 0.3% seasonally adjusted in Q4. Consensus was looking for a 0.7% increase. The 0.3% growth is trailing behind the significantly stronger 1.2% and 1% growth in the first and second quarter. On an annualized rate GDP rose 1%, well below expectations as well. The Government’s aggressive economic policy led to a kick-start for Japan’s economy in 2013. The stock market rose some 57% during last year, supported by the weakened Yen and a rise in business confidence. However, with the fiscal policy tightening the economic optimism is being put to the test. 2014 will determine whether Prime Minister Abe has what it takes to revitalize the economy for the future and (finally) leave the deflation behind. We expect Japanese GDP to grow by 1.4% in 2014, which is slightly higher than the 1% growth realized last year. However, we recognize that the Abe fever has faded sharply among consumers after he has decided to lift the consumption tax from 5% to 8% (to be implemented April 2014). As such, we will see real proof on the strength of the Japanese economy and willingness to spend at a higher prize when having the quarterly GDP numbers for 1H 2014, later this year.
After the Beige Book again upgraded the general economic activity in the US in January, we saw a somewhat more reluctant stance in the latest Beige Book (reported early March). While eight of the twelve Districts reported improved levels of economic activity, in most cases the increases were characterized as modest to moderate, compared to the previous edition when nine Districts grew at a moderate pace. Unusually severe weather conditions in many areas hurt spending, hiring and manufacturing alike, while the outlook among most Districts remained optimistic.As such, the Beige Book is suggesting that the recent string of weak economic data is indeed weather-related. Even though we do not highly disagree with this conclusion, we will recommend awaiting economic indicators for the coming months before we finally conclude upon the US economic temperature. Currently, the consensus seems to calibrate its view and conclude that the latest Beige Book was a “harsh weather report” and not a report that gave signals of harsher economic environment. As said, we find it premature to conclude upon such essential issues.
The global economic growth is still fragile when it comes to geo-political issues. The latest political turbulence in Ukraine adds on to a turbulent geo-political situation. We will not be too brave and conclude upon an outcome of this conflict. However, we are pretty sure that this is not a quick fix and a conflict that evolves into a brutal military conflict, cannot be ruled out. China is still on the sideline in this conflict, but sources have told international media that Chinese official(s) have given President Putin full support for actions taken inside Ukraine in general and on the Crimea peninsula in special. Furthermore, the Syrian conflict is definitely still on. The conflict has turned more evil and brutal than ever and every peace process talks seem to have ended. At least for the time being.
Furthermore, we like to add on that the European recovery is still in an early phase and changes in sentiment will probably widen credit-spreads and lift interest rates in the most vulnerable Euro-economies. If so, the expectations of a marginal positive growth might turn sour and again hit a negative growth momentum.
Overall, our main message is still that the global economy is on a growth track. We find the low interest rate regime as being supportive for the growth expectations. Contrarian, indications of currency issues in the emerging markets that might spread to smaller and fragile economies in the western world. In addition, signs of improved labor markets and improving consumer and business sentiment indicators have become somewhat more blurred lately. As such, the global economy highly dependent on fiscal stimulus in major economies and that the world trade is not hurt by conflict related disturbance due to political decisions or from a lack of trust in the future amongst capital spenders and consumers.
By Lars-Henrik Røren, Head of Investment Strategy