Global equity markets had a neutral month in general and MSCI World yielded some marginal 0.2 per cent. However, deviations between regions and countries were significant. The Moscow RTS index was down 3.25 per cent during March after gaining some ground late in March after a more massive downturn in the middle of the month. The Russian stock market has had an awful Q1 2014 with a total value reduction of some 15 per cent.
The Ukraine/Russia conflict raised many questions during March. Economic consequences from this conflict as well as impacts on the globally important Ukrainian agriculture output this year is somewhat out in the blue. In this “Economic outlook” we will focus on the economic situation in Ukraine and the countries surrounding this conflicted country.
Overall, the gradual economic recovery seems to continue in much of Eastern (including Central) Europe, although the growth outlook in Russia and Ukraine has deteriorated further due to the complex conflict between these countries. Direct trade ties between individual countries and the two adversaries are relatively small, except for the Baltic countries. The continued economic upturn in Germany and elsewhere in Western Europe will partly offset lost exports due to weak Russian demand. There is also good potential for higher private consumption. However, SEB is generally lowering its 2014-2105 growth forecasts for Eastern Europe, and the risk of short-term reversals in individual countries has increased due to geopolitical turmoil. SEB's forecasts are based on the key assumptions that the Russia/Ukraine conflict will not escalate militarily, no large-scale trade sanctions will be introduced and no serious disruptions will occur in Russian energy deliveries to Europe. Both the Western powers and Russia will certainly hold back as long as they can before starting any trade war.
The underpinnings of the euro zone's nascent recovery are still fragile and there is significant mutual dependence on Russia’s natural gas deliveries. Most Eastern European economies - with Russia and Ukraine as notable exceptions - began a recovery in the second half of 2013. The improvement has been most visible in the central region, which has benefited mainly from faster growth in Germany and the stabilization of the euro zone economy and banking system. The recovery will continue at a steady pace and become more broad-based. Meanwhile, exports will remain a key driver, although sluggish Russian economic growth will dampen momentum. In many countries, domestic demand will increasingly take over as the main economic engine. Continued low interest rates and fiscal policy loosening will provide support. Private consumption will be fuelled by good real wage growth, partly as a result of low inflation attributable to still-idle resources (though these are small in Russia) and small increases in commodity prices; oil prices will fall somewhat. We expect capital spending to grow but not surge, since industrial capacity utilization is moderate and the still relatively tight credit conditions in the wake of the euro zone crisis are thawing slowly. Geopolitical turmoil will also hamper willingness to invest in certain countries. As such SEB in March lowered GDP forecasts for the six countries that our Eastern European economic research covers: sharply in the case of Russia, Ukraine and Estonia; moderately for Latvia; and slightly for Poland and Lithuania. As such, we will summarize the GDP expectations for the mentioned countries
Russia's GDP will increase by a modest 1.0 per cent in 2014 and 1.8 per cent in 2015, well below potential growth of 2-3 per cent. In the short term, growth will be inhibited by the falling rouble and stock market and in the long term by weaker investments. The rouble will fall somewhat further against the USD but will stabilize against the USD/EUR basket over time. Our opinion is that the Ukraine conflict will worsen an already weak economic situation, which has largely been caused by structural problems, further accentuating the need for reforms. One of the few bright spots for Russian growth during the coming year might be our expectations of relatively stable oil prices. The current situation for European gas prices is that they have hit low price levels not seen since 2010, which will hurt Russia's economy, due to lower valued gas exports to Europe.
Ukraine is in an acute current account crisis, which will be eased by a large bail-out loan from the EU/IMF. In the short term, continuing depreciation of the local currency will squeeze the country's banking system and households, but over time it will help sustain a cautious recovery. GDP will fall by 4 per cent this year and rebound by 2 per cent in 2015.
Poland is showing good resilience to the Russia/Ukraine conflict. Imbalances have decreased significantly in recent years and are small today. Domestic demand is rising, and due to low inflation the first key interest rate hike will not occur until early 2015. GDP will increase by 2.7 per cent in 2014 and 3.4 per cent in 2015.
Estonia's strongly export-dependent economy will be squeezed not only by slower Russian growth but also by sluggish economic performance in Finland and a continued decline in public sector investments this year. A recovery will begin only in 2015; GDP will increase by 0.5 per cent in 2014 and 2.5 per cent in 2015.
Latvia's economy will lose some momentum after several stable, relatively strong growth years – fastest in the EU. Exports, transit trade, tourism and capital spending are being hampered by Russia’s weakness and uncertainty. Strong real incomes will provide continued support to household consumption. Unemployment will fall somewhat further. GDP will grow by 2.9 per cent in 2014 and 3.4 per cent in 2015.
Lithuania is poised for a recovery in domestic demand, starting somewhat later than in the other Baltic countries; GDP will thus increase by 3.0 per cent in 2014 and 4.0 per cent in 2015. Growing incomes, lower unemployment and the beginning of a housing market upturn will bolster consumption. Meanwhile, exports will cool due to weak Russian demand and decreasing competitiveness as wage growth exceeds productivity growth, but inflation will be low during the next couple of years. There is a very high probability that Lithuania will qualify to join the euro zone in 2015, as planned.
With this said, we still put our attention to the larger economies: China, Japan and the US. They are still by far the most important countries and regions to follow when measuring economic trends and the overall direction of the global economy.
The Chinese economy is still fragile. It seems like underlying economic sentiment indicators are somewhat bearish at the moment, whereas PMI surveys continue to show signs of a struggling real economy at the moment and for the quarters to come. We find the mid-April Q1 GDP announcement to be of high interest as such. The expected GDP growth rate for Q1 2014 is 7.3 per cent (annualized). We foresee more downside risk than of the opposite ahead of the release (April 16) and expect the Chinese economy to continue to be in a mood where governmental stimuli programs are highly needed to keep industry production and GDP figures above desired levels. We believe the governmental target of 7.5 per cent growth is stretched and will therefore open up for further needed fiscal programs later in 2014. We follow the Chinese economic outlook closely, aware of that a potential (material) slowdown in China will have almost imminent spill-over effects on global GDP outlook in general. As such, 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.
Disappointing Japanese export data still raises concerns. Export data from Japan released in March continued to disappoint. The fact that the weaker JPY has not yet lifted exports raises questions about the prospect of whether increased external demand will be able to compensate for the domestic slowdown after the VAT hike early April. However, BOJ’s Kuroda was out speaking in March and said: BOJ is only halfway to achieving price target and that adjustments will be made if needed to reach 2% inflation. BOJ Board member Mr Kiuchi was somewhat more cautious saying the hurdle for any additional easing is high and that the bad effect from a weaker JPY could exceed the positive effects.
We had no material news out from US during March. The tapering continues as expected and economic data points were more or less as expected. The US stock market was volatile during the month, but ended up in a positive territory with some 1.3% return (Dow Jones) during March.
Overall, our main message is still that the global economy is on a growth track, but fragile when it comes to geo-political issues. The political turbulence in Ukraine adds on to a turbulent geo-political situation. We will still 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 the possibility of a brutal military conflict, can’t be ruled out. Furthermore, we would like to add 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. We find the low interest rate regime as being supportive for the growth expectations. The global economy is highly dependent on fiscal stimulus in major economies and a prevention of a hurt world trade as a result of geo-political conflicts, or from a lack of trust in the future amongst capital spenders and consumers.
By Lars-Henrik Røren/Head of Investment Strategy