Global spotlight

Global spotlight is a short topical article on different themes in the financial markets written each week by senior fund managers, analysts and members of the strategy team at Standard Life Investments.

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What do Frankfurt, Seoul, Copenhagen, Sydney, Mumbai, Belgrade, Ankara, Budapest, Jerusalem, Warsaw, Nairobi, Tblisi, Colombo and Hanoi have in common?

23 May 2013

They are, of course, the cities where 14 central banks are located, the 14 central banks which have cut interest rates in the past few weeks.

It is very clear that the global economy has slowed in recent months. If we look back to the forecasts for economic growth in 2013 which were made back at the end of 2012, the consensus expected growth of 8.1% pa for China, 2% pa for the US, 0.7% pa for Japan and -0.1% for Europe. Looking at these 4 largest economies, only one has seen a major upgrade to 2013 forecasts, namely Japan, now expected to grow about 1.5% pa this year. There has been little change for the US, and noticeable deceleration in China and a deepening recession in Europe.

In practice, this can be seen in several ways – the deceleration in retail sales in China or the US, the build up of excess inventories which companies are reporting, the declines in order books seen in business surveys. The causes are several fold – sequestration in the US, anti corruption drives in China, restraining luxury spending, and fiscal austerity biting into activity in the European periphery.

2011 and 2012 were years characterised by risk-on/risk-off trading by investors. On several occasions, markets sold off very sharply on fears of double dip recessions or major slow-downs. However, this has not been the case in 2013 - far from it. The US stockmarket has risen over 14% year to date, the UK is up about 12%. Even the classic ‘sell in May and go away’ phenemenon has not been seen - so far - this year!

What is different this time? The answer is greater confidence amongst investors that the current slowdown will not be too dangerous – hence the significance of interest rate cuts from the central banks of Europe, Australia, Korea and their colleagues.

There has been additional support though. The most significant has been the Bank of Japan’s acceptance of quantitative easing, pushing the yen/dollar exchange rate through 102, a level last seen five years ago.

Not all the changes have been on the monetary side though - fiscal policy is being eased. It is very noticeable in recent weeks how the tone and tenor of the debate over austerity has changed. France and Spain are taking two extra years to reach their fiscal targets. The IMF has changed its recommendation to the UK on how quickly it should reduce the borrowing requirement.

Correlations are changing within financial markets. In 2011-12, a rise in the US dollar was normally associated with risk aversion, as worried investors brought money back to the safety of the States. Roll forward to 2013, we can see financial repression is working as a policy. Bond prices are rising, and yields are declining, as interest rates are either cut or look set to remain lower for longer. Equity prices are rising as income from dividends looks rather attractive compared with the low returns from interest rates or government bonds. The US dollar is rising as investors look for growth opportunities, and still see the US as more attractive than other parts of the world.

Where next? This is where we must use our Focus on Change approach. The more positive scenario would be that the easing of policy is successful, both in terms of generating employment but especially corporate earnings. There is a risk, however, that this upturn does not appear, that companies report successive quarters of stagnant profits growth. In the most recent quarter, non-financial earnings in the US were only up 4% from a year earlier. If companies run down cash holdings to pay the dividends which income starved investors demand, so tensions may start to rise. That need not matter, as long as policy makers remain supportive. Fourteen central banks have cut rates. Are any further announcements seen positively, as bolstering economic growth, or seen negatively, as a sign of weak growth? We may have escaped ‘sell in May’ - and the drivers to buy risk assets clearly remain in place - but the dangers of the autumn sell-off have not disappeared.

Andrew Milligan – Head of Global Strategy, Standard Life Investments