Overview
The key drivers of gloom earlier in 2016, as well as more recent enthusiasm, have been oil, China and U.S. Fed policy.
Commodities news has improved materially from a few short weeks ago. OPEC and Russia seem to be moving toward a saner oil production level, even as Iran may be allowed to increase its exports. That’s helped oil prices recover, reducing stresses the world over. So, too, has the perceived risk surrounding China, as its leadership increasingly seems able to engineer a gradual slowdown in growth.
The Federal Reserve also just disclosed a shift toward greater caution, so rates may not rise as fast as previously hinted.
And yet, profits aren’t exactly stellar. Will they remain under pressure or will the extraordinary drop in oil and other commodity prices of the last 1-2 years ignite a re-acceleration? Truly the question for our times.
North America
Tony M. Caxide, CFA®
Chairman - Senior Investment Council
Our U.S. macro economic dashboard shows more negatives than investors would like. Manufacturing remains under pressure. Headline inflation is again near zero, as the commodity price weakness of a couple of months back works its way through import prices, producer and even consumer prices. Even some jobs indicators – ‘til recently an area of uniform virtue – now show some early cracks.
That said, if one burrows more deeply, one also sees several signs of improvement. Early readings of March manufacturing activity look much better – but they are regional and anecdotal, thus not yet reliable. Core inflation, quite unlike headline inflation, has recently even exceeded the 2% pace that the central bank wants.
This “yes-but” environment has defined what is already one of the longest post-war recoveries on record. And it doesn’t look about to end either.
Japan
Jeffrey G. Wilkins,
Deputy Chief Investment Officer
The relative strength of Japan’s currency appears to be one of the primary stumbling blocks for Prime Minister Abe and his Central Bank Governor. Despite a very aggressive easing program, many small-but-effective reforms, and a recently announced negative interest rate policy, the yen remains only slightly weaker than its 10-year average. While global risk aversion may be partly to blame, more likely the greater factor is that Japan’s major trading partners are no longer tightening their monetary policy on a relative basis. Abe’s drive for higher wages and consumption may require more stimulus, be it monetary or fiscal in nature. The upward price momentum Japan has gained in many areas likely still needs to translate to higher wages in order for inflation to be sustainable.
Europe
Srinath Sampath, CFA®, PhD
Managing Director, Portfolio Management
On March 10, ECB President Mario Draghi expanded bank stimulus by further lowering its lending rates, increasing its asset purchases from €60 to €80 billion per month and, moreover, expanding the types of assets eligible for acquisition, and launching two long-term refinancing operations to aid bank borrowings. The Eurozone unemployment rate has been steadily ticking down, but still exceeds 10 percent, while core inflation is currently running below one percent – a far cry from the stated ECB target rate of just inside two percent. On more than one occasion, Draghi has emphasized that he is ready to do “whatever it takes” to kickstart member economies, and this recent program expansion appears to be another critical step in the right direction.
UK
Jeff (Shengde) Liu, CFA®
Managing Director, Portfolio Management
The U.K. economy grew 1.9% in 2015 – one of the strongest among major developed countries. Decade-low unemployment and strong wage growth have boosted the consumer sector. The manufacturing sector, however, continues to lag due to weak external demand. Corporate earnings are also disappointing due to higher labor costs and the collapse in oil prices, which hurt oil-related sectors. The forthcoming “Brexit” referendum casts more uncertainty. The Bank of England is likely to delay tightening.
Emerging Markets
Jeff (Shengde) Liu, CFA®
Managing Director, Portfolio Management
EM economies experienced slow growth last year, relative to their historical norm. The main reasons were the strong dollar, collapsing oil and commodities prices, and China. Going into 2016, the EM manufacturing sector is still contracting. Recently, a lot of attention has focused on China, particularly its highly leveraged credit system. China’s debt has tripled since 2009 from $10 trillion to $30 trillion, with most increases seen in the corporate sector. This has led some investors to worry about an imminent banking “crisis” and a collapse in the Chinese currency (RMB).
We take a more sanguine view. Although high debt can hurt corporate earnings in a lackluster economic growth environment, we don’t see a collapse in RMB or an imminent banking crisis. In China, most leverage is in local governments and state-owned enterprises (SOEs). In fact, 80% of total bank loans went to SOEs. Since all banks in China are state owned, this gives the government great “say” on when and how to deleverage, and therefore booms and busts do not necessarily need to happen in China. Furthermore, with foreign reserves of more than $3 trillion and a high export level, China has the ability to defend its currency.