Overview
The global recovery remains unsatisfyingly volatile, weaker than the norm and uneven from region to region…and satisfyingly stubborn. The U.S. is bouncing back from a brutal winter and near 0% growth. Japan has done OK, but questions remain about reform and her seemingly nationalistic leadership. The UK is close to booming conditions (at least by the standards of this recovery) and yet continental Europe is toying with deflation, and growth barely reaches 1%. And clarity for the future of emerging markets seems as elusive as ever.
So, just about normal for a global economy recovering from the excesses of credit bingeing.
Nothing is certain. But most of our causal factors, like monetary policy and even fiscal policy, continue to favor moving away from, rather than toward, an economic precipice. The private sector – both households and corporations – continues to heal globally, and even European peripheral borrowers and major European banks have gone a long way toward strengthening their balance sheets. And that’s no small thing given where they started.
North America
Tony M. Caxide, CFA®
Chairman - Senior Investment Council
The U.S. economy is rebounding from a temporary lull, driven by an unusually severe winter that led doomsayers to once again project another downturn, but which, instead, seems to be turning into yet another failed prediction of woe.
Although the rebound seems broad-based and convincing, and stocks are generally near record highs, many investors and the financial press are again focused on signs of weakness. Small-cap and some technology stocks are falling from expensive levels, as we’ve expected. A rally in bonds has driven yields down around half a percent from recent highs, leading many to argue that the Fed will have to delay its tightening. We, instead, see more and more signs of decent, sustained growth (in jobs, production, retail sales and other sectors) and gradually accelerating inflation. That’s OK – we quite like it when we’re out of synch with the consensus.
Japan
Jeffrey G. Wilkins,
Deputy Chief Investment Officer
Japan’s April sales tax increase drove many economic indicators substantially higher in March, as consumers accelerated their purchases before the tax increase. Now many of those same indicators are showing weaker numbers in April. The higher tax certainly helped Japan achieve real annualized GDP of 5.9% in the first quarter, but likely at the expense of future months. While the tax may present some short-term volatility in Japan’s economy, it may not hurt 2014 profits in a meaningful way. If the central bank remains committed to stimulating growth and defeating deflation, in part at the expense of the yen, Japanese companies should continue to see profit growth in 2014.
Europe
Srinath Sampath, CFA®, PhD
Managing Director, Portfolio Management
The European economy continues to attempt a gradual improvement against a backdrop of weakness in some areas. Unemployment rates near record levels, a preliminary Q1 GDP print of only 0.8%, and anemic inflation rates in the currency bloc are causes for concern. Offsetting these negatives are improvements in other areas, including trade balance, bank lending standards, new car sales and industrial production. Indicators also suggest continued expansion in the manufacturing sector.
All eyes are focused on European Central Bank president Mario Draghi, who has maintained the refinancing rate at 0.25%, and has telegraphed the possibility of launching a variety of unconventional stimulus measures in June.
UK
Jeff (Shengde) Liu, CFA®
Managing Director, Portfolio Management
The UK economic recovery continues to gather strength. Growth of just under 3% in 2013 seems to have carried over to 2014 with relatively low inflation. This Goldilocks situation enables the Bank of England to continue its loose monetary policy. Both manufacturing and service indicators are robust, which historically supports strong earnings growth. Manufacturers’ optimism surged in April to the highest level in more than four decades. Consumer sentiment continues to pick up with the healthy housing market recovery. Even the labor market presents a much better picture, with employment improving and wage growth starting to trend up. We believe that the deleveraging in the UK is on a successful path and is likely to grow faster than other G7 members in 2014.
Emerging Markets
Jeff (Shengde) Liu, CFA®
Managing Director, Portfolio Management
Emerging markets (EMs) remained under pressure in early 2014. Manufacturing indicators suggested a weak pace of activity. Exports fell vs. one year ago. It seems that rising policy rates (to defend domestic currencies in some countries) and the slowdown of the Chinese economy have started to take a toll on developing economies.
Reforms and restructuring continue in China. However, China is facing a lot of challenges: local debt burdens, shadow banking, a real estate bubble, pollution and increasing social tensions. These problems are tiring the hands of the new leaders. President Xi recently openly admitted that “slower growth is a new normal for China.” The Ukraine crisis has put frost on the already cold Russian economy. Brazil continues to face slowing growth and a high inflation challenge. Indonesia just adjusted its growth projection downward.
That said, we do not expect EM markets to collapse. Cheap valuation measures should provide a strong cushion for EM markets to weather the macro headwinds.