Market Overview: Developed world to lead 2014 global growth
Avinash Amin, Siguler Guff
In the US he sees a ‘three for three’ pattern of roughly 3% real GDP growth for the next three years, as the US completes the second half of what he predicts will be a seven-year economic expansion. Hoey says monetary policy under new Federal Reserve chairman Janet Yellen will be “very supportive” of that expansion, as inflation remains below the Fed’s target and the labour market is far from full employment. “Because the initial years of expansion were so slow,” he says, “inflationary pressures have not built up.” In his view, the implications of ‘Yellenomics’ is that US monetary policy could remain stimulative until after the next US presidential election in 2016, with meaningful tightening postponed until 2017 or 2018. He assesses that future budget battles will end in a low level status quo stalemate rather than repeating the recent pattern of disruptive major clashes over budget policy.
For the rest of the developed world, Hoey sees growth improvements in 2014. Stagnation in the UK, he says, has given way to a sustainable expansion. In mid- November, the Bank of England (BoE) under its new head, Mark Carney, indicated unemployment in the UK might be improving more quickly than expected and said there was a 50/50 chance that the jobless rate could fall to 7% by the end of 2014, sooner than its original projection of the summer of 2016.1 Under its forward guidance policy, the BoE has cited 7% unemployment as the threshold for considering raising interest rates.
While Hoey believes the eurozone will remain intact, he says the consequences of a continued ‘one-size-fits none’ monetary policy for disparate countries will contribute to a sluggish pace of expansion. He expects the eurozone to grow by only 1% to 1.5% in 2014 even after the EC B’s surprise rate cut in November 2013. As for Japan, he expects moderate expansion under the triple-pronged policies of Abenomics to persist after a volatile pattern of pre-buying, then payback, due to the hike in the value-added tax scheduled for April 2014.
The picture for emerging countries in 2014, he says, is more challenging and differentiated, both by initial conditions (current account, interest rates, credit growth) and by questions about the credibility of some countries’ economic policies over the medium term. Countries with large current account deficits, he says, will remain sensitive to swings in financial market sentiment. However, he believes Fed tapering of asset purchases in 2014 will be less disruptive for emerging markets than the talk of tapering in 2013, since the gap between the current QE-suppressed Treasury yields and free-market levels has already been reduced.
Good news for markets
On the whole, this macroeconomic backdrop is good news for the world’s capital markets in general and risk assets in particular, says BNY Mellon chief global markets strategist Jack Malvey. While acknowledging that positive GDP growth does not necessarily correlate with strong market outperformance, he says there are a number of factors that will be supportive of global equity markets in 2014.
He believes the US equity market will continue to rise during 2014, as company earnings continue to advance, but at a slower pace than in 2013. “Some companies will be more sluggish than others,” he says, “but overall the uplift will be constructive.” In addition to earnings, he points out that dividend increases are running at a record rate and M&A activity continues to pick up. Equity buybacks also remain strong. Moreover, 2014 will continue to be challenging for fixed income as QE tapering could effectively lead to modest rate rises. All of those elements, he says, will likely drive investors toward equities.
“We’ve gone from a risk on/risk off environment to simply a static position of risk on.” Citing the enormous gains in tech stocks in 2013, Malvey says it’s understandable a debate has begun about whether we’re seeing a return of the tech bubble of the 1990s, but he believes the run-up in tech stocks will persist for another few years. “You might get to bubble status, but I don’t think we’re there yet. I think we’re seeing a shift in sentiment from old economy to new economy sectors. You see that reflected in the excitement over big data and social media and the new ways people are doing business.”
Malvey expects the so-called ‘Great Rotation’ out of bonds into equities will continue this year. While institutional investors are several years into that switch, retail investors and European investors still have a way to go, he says. In Malvey’s view, European investors have not been as bullish as US investors because of the scars they still carry from the financial crisis and the longer downturn they have had to endure. But Malvey believes that over the mid-teens, more European investors will return to equities.
Return of enthusiasm for EM
An important market theme for Malvey in 2014 will be a return of enthusiasm for emerging markets in both equities and bonds, after challenging performance in 2013. “The decoupling of emerging markets debt from high yield in 2013 was notable, as we hadn’t seen that for a while. In 2014, I would submit that EM debt might rival or even surpass high-yield corporates. However, he points out the importance of analysing EM opportunities on a case-by-case basis.
“Global credit markets in both high yield and investment grade continue to enjoy a tremendous run,” Malvey says. “We’ve seen record origination as treasurers correctly perceive that this is a good time to finance [their businesses] with low spreads and low rates, extinguishing some of the prefundings required over the middle part of the decade.”
Malvey shares Hoey’s view that QE tapering in 2014 will not be disruptive to the markets over the medium to long term, though he says there could be a “roller-coaster bump” that will cause valuation adjustments in the markets for approximately a week to a month. “In the big picture, the fact the Fed will be buying fewer debt securities on a monthly basis is almost irrelevant given the scale of the entire market. If the world capital market choice-set is at least US$383 trillion, it’s statistically insignificant if in one month in 2014 the Fed buys US$10, $20 or even $40 billion less in securities.” Even if tapering causes rates to rise somewhat, say 10-year Treasuries go from2.70% to 2.95%, “those are still very low rates.”
China remains a question, Malvey says. While he agrees with other observers that the pace of Chinese GDP growth will slow from over 7% to somewhere in the high to mid-6% range over the course of the next four to five years, there are still many unknowns around how the world’s second largest economy will manage its shift to a new model of growth.
As for other potential sources of downside risk during 2014, Malvey sees them as possibilities rather than probabilities. “There is the gravitational pull of mean reversion and the extent to which the market feels heavy after such a big advance in risk assets over the past few years.” Unexpected geopolitical events are always a possibility, he says, “but the current period feels relatively dormant compared with previous periods over the last 10 or 15 years.” He says the 100th anniversary of the outbreak of World War I in August, however, will provide a potent reminder of the unpredictable events that can completely change the course of human history. High-frequency-trading technical glitches, he reminds us, remains another lurking source of potential market instability.
Beyond the short-term market influences in 2014, Malvey believes there are important secular shifts underway, whose contours are not completely known to us but whose influences are already being felt. These include everything from how new market regulations will ultimately be implemented to the global economic convergence of advanced and emerging economies; the normalisation of monetary policy around the world; a new major wave of technological changes in areas such as life sciences and big data; demographic shifts and intergenerational negotiations over entitlements and the funding of longer retirements; as well as the emergence of new investment opportunities and instruments as the financial landscape is resculpted. “This is truly the best time in history,” Malvey says. “Risks remain, but so far global capital markets have responded quite favorably to the unfurling of the 21st century global financial system banner.”
1 Chris Giles and Claire Jones, “Bank of England Accelerates Job Forecast” Financial Times, November 13, 2013.