The big chill
Posted on 7 February 2014
The thaw may take a month or two to come through, but when it does we think expectations of future growth will have been little affected.
The ISM manufacturing survey in the US is one of the best-established cyclical indicators there is. So when this week it registered the sharpest decline since October 2008, we had to take notice – as did global stock markets, which were already nervous on account of signs of more local difficulties and civil unrest in some emerging economies. At one stage this week, developed stocks were down 6% from their 22 January post-crisis high, and 5% in 2014.
However, on closer inspection the data are likely affected by the severe weather – as have been several other recent releases (including December’s employment report, and possibly today’s for January). The thaw may take a month or two to come through, but when it does we think expectations of future growth will have been little affected.
The worries in the emerging world may persist a little longer. If it does lurch unexpectedly into crisis – if, say, continued portfolio outflows trigger retrenchment by nervous governments and central banks – the impact could be material. The emerging world these days accounts for roughly two-fifths of the global economy in nominal terms, and perhaps one half in inflation-adjusted terms. However, we think in practice it may not be.
The main deficit countries in the bloc are running a collective current account deficit of perhaps 0.5% of global GDP, equivalent in scale to a fraction only of the bloc’s contribution to annual global growth. China is also at risk of course, not because of possible funding difficulties – it is running a current account surplus of 0.3% of global GDP, and has capital controls in place – but because shadow banking difficulties might trigger a credit crunch (we doubt it, but they could). And there would be spillovers to the developed world as emerging imports fall. But overall, we suspect that the impact of plausible emerging bloc retrenchment now might be smaller than recent forecasting errors: the standard deviation of annual global GDP growth has been around 1.5-2.0 percentage points in the last decade.
Financial markets are more volatile than economies, of course, and developed world companies increasingly benefit from profits made in the emerging bloc. But the emerging world’s financial markets are less developed than its economies: emerging stocks and bonds account for around 10-20% only of global securities markets (depending on the benchmark used). A worst case scenario now might perhaps be a crisis on the scale of the one that unfolded in Asia in 1997 – a year in which the all-country MSCI stock index rose by 15% in dollars (with a further 22% following in 1998, the year Russia defaulted on its ruble bonds).
All told, we continue to see 2014 as another positive year for risk assets. We see the business cycle and relative valuations continuing to favour stocks over most other asset classes in 2014 as a whole. We are still broadly positive on developed markets (our preferred regions remain the US and Continental Europe), while the chill in emerging markets may last a little longer.
Kevin Gardiner, Chief Investment Officer, Europe