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Tectonic shifts in the world economy

10-07-2013 | News item | Léon Cornelissen The Fed continues to hold everyone in its thrall as markets kowtow to chief Bernanke’s verbal departure from uber stimulus – but have things gone too far?

Speed read
  • Below-trend global growth set to continue
  • Fed policy – a waiting game
  • Emerging Markets – sentiment has turned sour
  • Recent sell-off enhances appeal of High Yield
  • Equities still on course to move higher
  • Political tensions in the Middle East and European periphery


Robeco Chief Strategist Ronald Doeswijk thinks they probably have and that “Fed tapering is less imminent than the market expects”. With the PCE price index, the Fed’s preferred inflation indicator, still hovering around 1% and a hefty downward revision for Q1 GDP (from 2.4% to 1.8%), tightening doesn’t really seem to be just around the corner. This notwithstanding, and despite Mr. Bernanke’s assurances that policy is data-dependent, as Doeswijk put it “the tightening consequences of his remarks were felt worldwide”.

But for Doeswijk, the key question is whether the US economy is strong enough to cope with tightening, especially in the light of what he terms the “fragile global environment”. 
  
Japan - bright spot in the Pacific?
The Japanese economy continues to look positive. The Q2 tankan shows what Doeswijk refers to as “a clear improvement in business sentiment among major manufacturers” and this is supported by expectations for strong Q2 economic growth.

The yen has continued to weaken against the dollar, breaking the psychological 100-level at the end of June. Although bond market volatility has increased, 10-year yields are still hovering below 0.9%.
 
Europe – signs of stabilization do not extend to the periphery
The euro zone is showing what Ronald Doeswijk terms “new signs of stabilization” with the composite PMI showing a slower rate of shrinkage (48.7).

Even such tentative signs of a pick-up should be enough to deter the ECB from further easing – especially with the uptick in headline inflation to 1.6% and the rising oil price.

Political tension is increasing in Southern Europe – the weakened Greek government is encountering difficulties in fulfilling the troika’s demands, while in Portugal the Prime Minister is attempting to avoid early elections.

The calm in the European bond markets is “fragile” according to Doeswijk, who does not expect the ECB to rush to bail out euro-zone sovereigns in trouble.

The global macro picture in numbers
3-kaders-9-juli-2013-eng.jpg 
  
Equities – set to move higher
Despite market fears resulting from recent Fed’s statements that have stopped equity market rallies in their tracks, Ronald Doeswijk maintains a ‘positive view’ and sees room for equities to move higher.

The US market has proved most resilient in the recent market turbulence and remains the favorite. The Fed is overly optimistic on growth prospects according to Doeswijk, who continues to favor risky assets and does not expect “the removal of excess liquidity through Fed tapering” until Q4 2013.

His preference is for defensive sectors in the current scenario, where more pessimistic or ‘risk-off’ sentiment still prevails.
 
BoJ offers shot in the arm for real estate
The outlook for real estate remains positive. In Japan, the BoJ has also targeted real-estate funds in its QE agenda, which “makes investors less nervous about overstretched valuations”, says Doeswijk. Dividends remain attractive and Doeswijk expects the recent interest rate rise to “moderate”, lessening the impact of interest rate sensitivity on this asset class.

“US economy not expected to accelerate in Q3, but to see moderate growth”
 
Emerging markets – sentiment has turned sour
EMD has suffered a double whammy of widening spreads and ongoing EM currency depreciation against the dollar, which has caused Doeswijk and his team to reduce their outlook to neutral for this asset class.

Risk in the form of Fed tapering fears compounded by heightened political tension in a number of major emerging markets (Brazil, South Africa, Turkey, Egypt) means that the trend of wider spreads and currency volatility is set to continue.

From an emerging market equity perspective, things are not much better with weaker underlying economic fundamentals, structural problems - like those in India, and subdued growth.

Chinese authorities have bitten the bullet, allowing interbank rates to skyrocket and seem to be more concerned about tackling the shadow banking system and discouraging speculation than in achieving what is becoming an increasingly ambitious 2013 growth target of 7.5%. 
 
Recent sell-off enhances appeal of High Yield
Chief strategist Doeswijk’s preference for High Yield has increased in the light of last month’s sell-off during which HY declined by 3.2%. With attractive running yields, a favorable interest-rate environment and default rates below historical averages, Doeswijk expects these issues to rebound. He also notes that covenant lite issuance, which has reached an all-time high, should not be a cause for concern as most is used for refinancing and not, as in the past, with the more risky objective of financing leveraged buy-outs.

Government bonds least attractive asset category
A further rise in global yields is not likely, after bond markets reacted negatively to the news that the Fed might taper its bond purchases. Still, Doeswijk thinks government bonds remain the least attractive asset category: “We expect riskier assets to outperform government bonds”.

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