Overview
As we circumnavigate the globe, the economic positives are numerous – each of the U.S., UK, Europe, Japan and even emerging markets is showing signs of improvement. That’s good.
We also observe that, aside from a few persistent – and consistently wrong – perma-bears, negative articles have been replaced by all these pundits projecting that the Dow will hit some high number by year end. Further, more money is being allocated to stocks, as investors are more comfortable with headlines. This, along with less-friendly valuations, is perhaps not so good.
We have just shifted our U.S. fixed-income assets to a more cautious stance with regard to higher interest rates. We’re also carefully reviewing our earnings projections and measures of equity market value to assess when a change in equities stance may be in order.
North America
Tony M. Caxide, CFA®
Chairman - Senior Investment Council
The U.S. survived another embarrassing bout with Washington’s (mis-)management of fiscal policy, including a government shutdown (which we anticipated but did not worry about) and another round over federal debt limits (which had the potential for more trouble). The essence of the matter is that we’re living through quite tight fiscal conditions, with a sharp reduction in the budget deficit (which everyone thought they wanted) taking a meaningful chunk out of U.S. economic growth near term.
The economy seems to have shrugged off the event. Most current indicators are showing moderate strength, even as autos and housing may be downshifting. Most forward-looking indicators – including our prized “causal” factors – are in green territory. Even fiscal policy may become less restrictive. Nevertheless, earnings growth and valuation top the list of things to watch like a hawk.
Japan
Jeffrey G. Wilkins,
Deputy Chief Investment Officer
While Prime Minister Shinzo Abe’s longer-term “third arrow” remains unspecific at best, the first two arrows of his three-stage plan do appear to have been effective thus far. While the broad economy experienced a slower third quarter in terms of GDP due mainly to weaker net exports, corporate profits appear to be growing robustly and industrial production is expanding at a healthy pace. Retail sales remain at a moderate level overall, but have picked up recently and will likely continue to accelerate ahead of the sales tax increase in the spring. Perhaps most encouragingly, core inflation is a positive 0.7% year over year and supplier prices suggest it will continue to track toward the central bank’s target of 2%, which would be a major development.
Europe
Tony M. Caxide, CFA®
Chairman - Senior Investment Council
Europe is showing signs of improvement in its periphery, albeit each of Portugal, Greece, Spain, Ireland and Italy remains under some form of economic pressure. The key to success comes down to public policy. These economies are benefiting from recent painful actions that meaningfully reduced costs and increased competitiveness. The disinflationary impact of these decisions and a strong euro led the ECB to cut rates, as inflation is running well below 1%.
The core nations show some divergence. Germany appears to be recovering, while France is struggling. Here, too, public policy is at play, as the Hollande administration’s archaic Socialist policies of heavy taxes, a large and heavy government hand, and anti-business and anti-wealth rhetoric and actions are having the predictable result of reduced well being for her citizens.
UK
Jeff (Shengde) Liu, CFA®
Managing Director, Portfolio Management
The UK is hitting a sweet spot of recovery: accelerating GDP growth and falling inflation. Selected indicators hint that GDP might be on track for even faster growth ahead. Annual CPI fell from 2.7% to 2.2% in October. Both manufacturing and services surveys have maintained strong levels. The housing market continues to improve. And the job market looks better and better, with the unemployment rate falling to 7.6% in September. That said, falling unemployment has yet to support pay growth. The annual wage growth in the UK was 0.7% in September, compared with 2.2% inflation. This partly explains the recent weakness in retail sales
Emerging Markets
Jeff (Shengde) Liu, CFA®
Managing Director, Portfolio Management
EM economies continue to face headwinds. Q3 economic growth was still weak due to the slowdown in China and declining commodities prices. Trade balances show little sign of turning the corner. Some EM currencies are still fragile, especially for countries with large external deficits – notably India, Indonesia, Turkey, South Africa and Brazil. To defend their currencies and fight inflation, these countries have had to raise interest rates, which may pressure their economic growth. Meanwhile, China still faces thorny problems, including local government debts, bad bank loans, persistent credit and property bubbles, severe excess capacity and, above all, the heated debate between right and left. Nevertheless, recent data in most EM countries suggest that the manufacturing sector may benefit from the recovery in Europe and the U.S., and our EM earnings projections still show a growth trend, albeit at a modest pace.