Economic Outlook January 2014

A volatile and lossmaking start to the new year

January showed negative returns for many asset classes. Global equity markets had a rough month in general and the broad picture showed volatile and negative sentiment for equities.  Furthermore, most mineral and metal raw materials generated negative returns in January. As such, the start of the year has been a risk-off market with equity fund outflows and bond market inflows. However, we still characterize 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 market economies.

With that said, we will still place our attention on the larger economies. China, Europe and the US are unquestionably the most important countries and regions to follow when measuring economic trends and overall direction of the global economy. China is still on a growth path, but there was some weaknesses in PMI and other growth indicators at the beginning of the year. This will increase the focus and give some head-ups in relation to the upcoming Chinese Peoples Party Congress that will take place in March. This is the arena where the economic growth ambitions for China might be reduced from the current 7.5% annual growth goal. A potential cut in GDP growth rates will have some economic spill-over effects to other global economies, both inside and outside the emerging economic world. We follow the Chinese economic outlook closely, aware of that potential slowdown in China will make strategists and economists look more cautiously on global GDP outlook in general.

As previously mentioned we still see the current economic environment as satisfactory. During January the World Bank raised its global growth forecast to 3.2% up from 3.0% while maintaining its call for US growth at 2.8%. This is the first time in three years that they raise the global forecast. However, they also warn that abrupt unwinding of central bank support in advanced economies could impose significant economic damage and throw some countries into crises as they estimate capital flows to emerging markets may contract by up to 80%. The World Bank report forecasts growth in developing countries to pick up from 4.8% in 2013 to a slower than previously expected 5.3% this year, 5.5% in 2015 and 5.7% in 2016.

The Beige Book again upgraded the general economic activity in the US since nine districts reported moderate growth in the current edition compared to seven districts in the December edition of the Beige Book. Retail spending had increased in three-quarters of the Districts while real estate markets continued to improve. The renaissance in the industrial sector is continuing; all but one district reported both growing sales and an optimistic outlook with respect to manufacturing. But what really caught our eye was that wages actually are starting to move up, albeit modestly.

After the FED decided to begin tapering of its quantitative easing (QE) program in December last year, the tapering continued as expected in January. The speed in monetary stimuli cut backs were according to what was communicated from the FED in December. As such, no surprises in any directions which built confidence that US has the economic growth and reduced unemployment  rate traction that the FED wants to see to support the initial tapering plan. The tapering is not expected to make the FED hike US interest rates until late 2015 and the speed of tapering will be tracked by labor market data and a continued improvement of unemployment rates as such.

The global credit and equity markets seem to be in a better shape by early 2014 compared to the situation in the beginning of last year. This is a result of a tight control of the banking markets and improved balance sheets due to improved asset quality and retained earnings throughout the year. As such, the banking sector and capital markets are in OK shape for now. This is the single most important factor for the global economy on its way to reach the 3.5-3.8% global GDP growth ambition for 2014: a growth estimate supported by most of the global central banks, macro economists, other financial markets stakeholders and agencies like the IMF and the OECD.

That said, the global economic growth is still fragile when it comes to geo-political issues. We still find the situation in the Middle-East worrying. 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 positive growth in Euroland in 2014 of 0.8-1% might turn sour and again hit a negative growth momentum.

On a final note we remind of our main message that the global economy is on a growth track. We find the low interest rate regime, improved labor markets and improving consumer and business sentiment indicators as encouraging. Contrarian, we see indications of currency issues in the emerging markets that might spread to smaller and fragile economies in the western world. The recent weakness in Turkish Lire is an indication that this situation has to be followed closely.   

By Lars-Henrik Røren, Head of Investment Strategy