Overview
Geo-political events have shadowed economic and financial markets in recent months. Between Israel-Gaza, Ukraine-Russia, Iraq-Kurds-“Islamic State” Sunni extremists, and continued turmoil in Libya, there’s so much to consider. That said (and as has most often happened), the markets were only moderately impacted by these exogenous factors, as most were judged to be either temporary or of limited global scope.
The U.S. economy appears to be in a convincing bounce-back from a harsh winter, and increasingly the consensus sees growth gaining more traction – possibly impacting inflation down the road. The U.K. remains on a tear. Continental Europe has slowed, impacted by sanctions on, and by, Russia and other factors. Japan’s growth collapsed in the second quarter as expected, after a tax increase that offset previously strong demand. Economic events in Emerging Markets remain unclear, although their financial markets have been strong indeed.
To the casual observer, it’s a cacophony of noise and it’s hard to discern any recognizable note. If you would like to focus on a single tune that might provide guidance, we would recommend monetary policy. Although somewhat softer than before, its decibels continue to scream “stimulus”.
North America
Tony M. Caxide, CFA®
Chairman - Senior Investment Council
U.S. growth has convincingly rebounded from a winter-driven contraction and seems to have an underlying pace close to 2.5% – about half a percent above its previous growth rate. Although the stock market recently vacillated, as we write this much of the pullback is behind us, making it similar to several 3-7% “pauses” we’ve observed in recent years.
Although markets are not discussing it yet (since year-over-year data lie close to 1.5%), we anticipate that inflation will soon become more hotly debated. Mind you, we’re not seeing a return to the 1970s, and this trend could still reverse, but the inflation pace of recent months has been closer to 3%. And although annual wage gains of near 2% are being dismissed, they have risen by about 1% in the last 12 months or so.
Japan
Jeffrey G. Wilkins,
Deputy Chief Investment Officer
After a strong first quarter, Japan’s economy sputtered in the second, posting a contraction of 6.8% on an annualized basis. As many expected, demand temporarily weakened in the months following the April sales tax increase. Despite this weakness in growth, inflation appears to be accelerating toward the central bank’s target of 2%. Employment measures such as the unemployment rate and the job-to-applicant ratio suggest wages could improve further. With most measures of economic activity flat or highly volatile in recent months, it’s unclear whether additional stimulus will be needed to return the country to steady growth and ultimately lower debt to GDP. But most investors continue to look for hints that reform will continue.
Europe
Srinath Sampath, CFA®, PhD
Managing Director, Portfolio Management
Despite steady improvement in the retail and service sectors, a modest depreciation in the Euro, and a gradual decline in unemployment rates from peak levels, weakness in the currency bloc persists. An advance Q2 GDP print of only 0.7%, lackluster inflation rates well below the target of 2% (in fact, convincingly below 1%!), and an ill-timed tightening of the European Central Bank (ECB) balance sheet have led to a very low refinancing rate of 0.15% and increased pressure on ECB president Mario Draghi to institute several stimulus measures in the coming months. We also continue to monitor the economic sanctions against Russia, which pose a material risk to European trade.
UK
Jeff (Shengde) Liu, CFA®
Managing Director, Portfolio Management
The UK economic recovery is claiming victory with growth projected to accelerate to a robust 3% or so. Thus far inflation has remained under 2%, the Bank of England’s (BoE) target. UK services strengthened more than expected in August. Manufacturing cooled down, but has shown expansion over the previous 17 months. The housing market continues to boom, with the UK average home price at an all-time high.
Despite robust growth, UK productivity growth is “still abysmal” (Financial Times, August 5) and wages are running below inflation. More recently BoE head Mark Carney said he saw some mortgage debt risk. The BoE’s rhetoric has become more hawkish and the equity market may overreact to these changes in tone. UK stock prices (FTSE index) were off about 4% since their June high, albeit impacted by other global markets.
Emerging Markets
Jeff (Shengde) Liu, CFA®
Managing Director, Portfolio Management
Emerging economies are still facing some tough challenges. The global recovery remains slow. China’s restructuring and transformation may continue to keep its growth in check. The credit-growth-driven models of most EM countries may become constrained as loan efficiency experiences diminishing marginal returns. And U.S. eventual interest-rate normalization to higher levels poses uncertainty to some emerging economies.
However, recent reform measures are bringing hope to EM economies from Mexico to Colombia and India to Indonesia. Investors also responded positively to election outcomes. China’s targeted stimulus has kept its economic growth in line with the government’s target rate (7.5%). With a dividend yield of 2.7% and trading at a P/E multiple of 13 times (MSCI EM Index), EM equity continues to look cheap. And returns of over 10% year-to-date in the widely-used MSCI EM index will increasingly tempt investors.