By Co-Head of Multi-Asset at Henderson Global Investors, Paul O’Connor
‘With the global economic recovery looking anything but even, we take a look at the economic landscape after nearly seven years of unprecedented central bank policy and at the implications for investors.’
The world economy has grown for six consecutive years since emerging from recession in 2009. That is no mean feat, given the headwinds of austerity, Eurozone flare-ups, the slowdown in China and the related slump in commodity markets. It has certainly not been a boring time for those involved in investments.
While the economy has managed to push on – mainly thanks to life support from central banks – these headwinds have taken their toll and the strength of the recovery has generally disappointed. This can be seen in the progression of consensus economic forecasts, which show economists downgrading their estimates of global growth, more or less continually, since early 2011.
The best of times, the worst of times
Another key feature of the post-crisis recovery has been its unevenness, most obvious in the contrasting fortunes of developed economies and the emerging world. The developed economies were hit harder by the financial crisis and recession than the emerging economies, but they have rebounded more decisively. For these economies, 2015 looks set to be the fastest year of growth since 2010 and the first year since then in which all of the G10 (Belgium, Canada, France, Germany, Italy, Japan, Netherlands, Sweden, Switzerland, UK and US) economies expand. It is a very different story in the emerging world, where 2015 looks set to be the weakest year of growth in seven years.
Of course, the diverging momentum between developed and emerging economies is only part of the story. There are significant differences within these groups as well. For us, the most meaningful way to capture the diversity across countries is to categorise them into the following three broad groups:
- Recovered economies, such as the UK and the US, which no longer need central bank policy support and now look strong enough to withstand interest rate hikes.
- Recovering economies, which are on the mend, but still need significant policy support. These include the Eurozone, Japan and South Korea.
- Vulnerable economies, which have poor economic momentum, financial frailties, policy credibility issues or some combination of these. Greece and the majority of emerging markets are in this group.
Naturally, these divergences in recovery are leading to meaningful policy divergence between countries. While central bankers in the recovered economies are now focused on timing their first interest rate increases, this must look like a nice problem to have to policymakers elsewhere. The latter are still focused on resuscitating struggling economies or nurturing fragile recoveries, often against a backdrop of structural inefficiencies and frailties in their financial systems. In these economies, interest rate rises remain a remote prospect.
More of the same
So, the global economy continues to face significant challenges, but it is nevertheless still growing, healing and pulling away from the global financial crisis. Our base case is for this to continue, albeit with episodic setbacks as the world’s financial vulnerabilities occasionally surface, as they have done recently in China and Greece. One positive aspect of this three-speed recovery is that inflationary pressures remain subdued globally, which should allow central banks to keep interest rates low for a long time. This means that, even though the recovery might be more sluggish and bumpy than previous upswings, there is a good chance that it will be longer as well.
Throw that rule book out of the window (sort of)
One key implication of this uneven global recovery is that financial markets do not have a playbook for it. When recoveries are so divergent, debt reduction such a powerful structural influence and when the magnitude of money printing by central banks is so colossal, the economics textbooks can stay on the shelf. Instead, asset allocators have had to adapt and need to keep adapting, recalibrating their models and giving greater emphasis to central bank policy, politics, and money flows, and less emphasis to established economic indicators.
While many features of the outlook described above seem set to persist for some time, we do see one key change in the months ahead that could have a lasting impact on financial markets. That is the move by the US Federal Reserve to raise interest rates. For us, this move and the similar action we expect from the Bank of England, will signal a regime-shift away from an era of central bank life support to a world with a bit less support but a bit more growth.
We are, therefore, in economic recovery, but not a textbook recovery. The economy may reflate, but price inflation may be less of a feature than in previous recoveries, instead manifesting itself through sporadic bursts in asset prices, or at more localised levels. Historical precedent can still guide us, but less so than in the past in this world of divergence, debt reduction and unprecedented central bank interventions. We expect surprises and volatility, but many opportunities to add value to our portfolios through careful asset allocation.
Past performance is not a guide to future performance. The value of an investment and the income from it can fall as well as rise and you may not get back the amount originally invested.
Nothing in this article is intended to or should be construed as advice.