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Global economy: Down but not out

21-01-2016 | Outlook | Léon Cornelissen
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“Things aren‘t going well, but apart from that everything’s fine.” According to Robeco board member Hester Borrie, this quote – from Gerard Reve’s book The Evenings – perfectly encapsulates chief economist Léon Cornelissen’s view on the situation in the global economy.

Speed read:
  • Fears of a Chinese hard landing are exaggerated
  • Oil price can only move higher in the longer term
  • Possible surprise on the upside in terms of growth
Cornelissen summarizes his outlook for 2016 as “Down but not out”. The message is clear: it would be fair to call the early stages of 2016 a false start and there are plenty of headwinds and potential dangers threatening the health of the global economy, but for anyone who dares to look beyond these, the future may look quite rosy.

The New Year has been characterized by nervous markets, thanks to a negative cocktail of falling oil prices, jitters on the high yield market and of course the heavy losses on Chinese equities. Cornelissen thinks that this sentiment is overdone. “The oil price has been falling sharply since 2014. In the very short term anything could happen – analysts are already engaged in a ‘race for the bottom’ with price targets approaching the USD 10 per barrel level – but for the longer term a stabilization in the oil price followed by a gradual rise is the most logical scenario.”

Cornelissen also feels that the fears about China are exaggerated. According to him, the Chinese government still has enough room to maneuver and the tools to do it with. And low inflation, partially thanks to cheap oil, is a plus. The Chinese government is also sticking to high average growth of 6.5% in its new Five Year Plan, which at least indicates its desire to keep stimulating the economy. The yuan has continued to fall in value in early 2016, but is still ‘only’ about six percent lower than it was in August 2015. So its depreciation is not terribly shocking, says Cornelissen. “Surprising at best, because during his visit to the US at the end of 2015, Chinese President Xi implied that the yuan would not be allowed to fall further.” A currency war is not on the cards in Asia for the time being as far as Cornelissen is concerned, although he does think that a gradual depreciation of the yuan is less practical than a one-off depreciation with a peg to the US dollar at a lower level. “Unrest prevails at the moment and we have to wait to see what impact the policy has.”

Inflation below 0%
As far as the oil price is concerned, many are focused on Saudi Arabia – which is still refusing to curb production, despite oil being far from profitable at current price levels. “Their strategy is ‘pump them to death’, but of course they have to be careful that that this doesn’t result in suicide.” The low oil price also exacerbates the problems of a country like Russia, yet on the whole Cornelissen thinks that the impact on the global economy – through consumers’ wallets – will be positive. “Major producers are now operating below break-even levels. Of course, this is untenable in the longer term.” It is inevitable then that we’ll see lower production levels and higher (stabilizing) oil prices in the course of 2016.

A higher oil price would automatically mean slightly higher inflation, something that the European Central Bank would welcome. But in the first few weeks of the year the oil price has only fallen further, which could push inflation levels in Europe back below 0% again. “The European economy is ticking over quite nicely, therefore it is quite understandable that the majority of the ECB board members called Mario Draghi to order at the end of 2015 when he proposed allowing inflation to pick up ‘quickly’, explains Cornelissen. He thinks the pressure ‘to act’ is now dissipating.

‘Germany can’t just close its borders as this would increase pressure on the frontline facilities in the Balkans and Greece’

At the same time Europe is struggling with a huge immigration problem, which Cornelissen thinks will lead to less emphasis on budgetary discipline. “German Finance Minister Wolfgang Schäuble was delighted with the surplus. But the ‘schwarze Null’ (a federal budget that is in the black or fully balanced) will soon evaporate, with the costs involved in providing refuge for the flood of immigrants. “And while the EU has porous external borders, a country like Germany can’t just close its gates, because this would increase pressure on the frontline facilities in the Balkans and Greece, with all the negative consequences that this step would bring.”

Scope for positive surprises
But there is certainly room for something other than all this gloom, says Cornelissen. “It is surprising that no one is daring to predict economic growth anymore. Even the IMF’s routine growth estimates are under fire. But if you look at the reduced need for austerity measures, ongoing ECB stimuli, including debt purchases worth EUR 60 billion per month, and the low oil price, we can’t rule out the possibility of positive surprises. In addition, although sentiment towards Europe is deteriorating in various countries, there are no major elections planned for 2016. Political changes in Germany and France are only scheduled to occur in 2017 and even the Brexit referendum doesn’t necessarily have to happen this year. “So the resurgence of populism shouldn’t become an issue in 2016,” says Cornelissen.

Bearing all this in mind, Cornelissen’s base scenario for 2016 is still positive. “We remain most positive on equities and high yield bonds. But there could also be opportunities in certain emerging markets. Russia and Brazil are likely to have their hands full, but buying opportunities could arise in other emerging markets.

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