Alex Cathcart, CFA, Economist – Portfolio Manager Support, Investment Strategy
Several weeks ago we began sharing some of the market reporting we regularly provide to our Investment Committee with you. This post provides an update on our thinking and views of the global economy and markets.
Global sentiment has improved over the past month, with investors taking comfort in China’s growth showing some resilience, and better economic data out of the US. The MSCI World Index has recovered around half of its drawdown, in a rally that left Australia and emerging markets behind. Fixed interest has performed poorly, as better US data brought forward market expectations that the US Federal Reserve (the Fed) will tighten monetary policy. Last time we remarked that key to the global outlook will be the extent to which the ongoing slowdown in the global commodity and manufacturing sectors will hurt the growth of developed economies. At present, the data suggests the impact remains limited.
In particular, it appears growth in the services sector of the US economy has accelerated again. Private sector employment growth has strengthened following a weak couple of months and surveys of activity point towards above trend growth. Real household spending remains around pre-GFC levels and housing construction is picking up steam. Conditions are almost certainly appropriate for the Fed to begin normalising monetary policy. Indeed, with an unemployment rate of just 5 per cent, some argue the Fed is already behind the curve. The piece of information the Fed is missing is inflation. Inflationary pressures in the global economy remain muted and nominal wages growth is sluggish by historical standards.
We think core inflation in the US will move towards the Fed’s target in the next year or so as the unemployment rate continues to fall and real wages pressures start to build. The Fed will likely begin normalising monetary policy shortly in expectation of this.
Outside of the US, we’re seeing a continuation of recent trends. China should continue to slow down, with ongoing policy stimulus supporting the economy’s transition away from manufacturing and construction towards services. We remain concerned about the chance for this transition to go awry. We are also concerned about very high levels of debt tied to sectors of the economy with significant overcapacity (real estate and steel and minerals processing) which could translate into a banking sector crisis and a material economy wide slowdown. We think the performance of other emerging markets will continue to be mixed. Those tied to China’s manufacturing sector and the broader commodity complex are likely to continue to perform poorly for some time yet. We also see a chance of liquidity crises in some emerging markets as they face the double hit of currency weakness and higher borrowing costs in the face of higher US interest rates.
The developed world story is more positive. Markets broadly expect the European Central Bank (ECB) to expand monetary stimulus at some point in the near future, which should continue to support the recovery in the currency bloc. We also expect Japanese activity to resume growth as the after-effects of their poorly timed and implemented consumption tax hike wash through the economy. The UK economy should continue to post robust growth and we expect the Bank of England to begin normalising monetary policy shortly after the US Fed moves. In Australia, the Reserve Bank of Australia (with the help of a much lower currency) continues to manage the transition away from mining construction well. The housing sector is supporting an oversized proportion of the current growth however, and this boost will likely be relatively short lived. A recovery in non-mining business investment is what is needed for sustainable growth beyond the mining boom.
The Balanced option continued to be relatively defensively positioned throughout this period resulting in the portfolio performing well in the recent difficult market environment compared to a more equity heavy portfolio. Currently we see global equities as moderately expensive. We added a little equity risk to the portfolio in the recent market drawdown as valuations improved modestly. However, we would be unlikely to add material equity risk without a material sell-off in markets.
Regardless of our positioning, a low-return environment means meeting real return objectives will be challenging in the coming years. You can read more about some of the things we’re doing to try to create returns which exceed those available from straightforward exposures to listed share markets and bond markets here on our blog.
The views of the author and those who provide the responses to comments posted on this blog are not necessarily the views of the QSuper Board. We’ve put this information together as general information only. You should get professional advice before relying on this information.
Past performance is not a reliable indicator of future performance. Each of our investment options has a different objective, risk profile, and asset allocation.
Economist – Portfolio Manager Support, Investment Strategy
Alex is responsible for forecasting major global economies, monitoring global economic and financial market conditions, and providing support to the portfolio managers.