Thursday, 17 March 2016

Currently the global growth picture masks some stark regional and thematic divergences between countries. A slowdown in growth to around 3.1 per cent in 2015 from 3.4 per cent was driven by a deceleration in growth among emerging economies while growth in advanced economies, accelerated slightly in the year.  There are three broad global forces driving these divergences:  global monetary policy; commodity prices; and the slowdown in China. So how do we think these factors will influence global economic growth over the remainder of 2016?

Beginning with the US, growth slowed a little in the second half of 2015, to around 2 per cent per annum, even so, US economic fundamentals remain very strong. However, the strength in the economy between 2012 and 2014 has driven the US dollar higher. This, and lower oil prices (which are partly driven by the strong dollar and partly by increased global oil supply) have driven the recent weakness in the manufacturing and export sectors. Nonetheless, financial market volatility and overseas weakness will likely keep the Federal Reserve (the US Central Bank) from delivering the four interest rate hikes it expected late last year. Through the rest of 2016, we expect growth in the US to stay around 2 per cent, which will continue to put minor upward pressure on inflation.

Growth in Europe has been trending modestly higher since 2013, hitting 1.5 per cent by the end of 2015. Aggressive European Central Bank monetary stimulus and a stabilisation in the debt crisis have seen credit channels re-open and some normalcy returned to the European Union. Europe has also benefited from a stronger US dollar and lower commodity prices. Growth of 1.5 per cent per annum is quite low by historical standards, but it is arguably around the high end of what the European economy can deliver given its potential growth. However, this is still sufficient to gradually close the output gap and reduce the unemployment rate. Regardless, the EU will likely not contribute to a meaningfully improvement in global economic growth in the period ahead. Meanwhile, the refugee crisis is putting pressure on the Schengen (free movement of people) agreement, leading to more support for populist fringe parties. 

China remains the largest swing factor in the global outlook. Growth is currently somewhere between four and seven percent per annum (official numbers suggest 6.8 per cent growth). This is a remarkable slowdown from the 15 per cent growth rates of 2007. Much of this slowdown has occurred in the past six years, as stimulus enacted to combat the financial crisis, has run its course. This stimulus left a legacy of debt and over capacity across the real estate industry and state-owned enterprises. The question remains whether this legacy will eventually lead to crisis in China, or if growth in other sectors of the economy will allow China to grow out of its imbalances. If China continues to slow gradually, global growth should be relatively unaffected. China’s economy is roughly double the size it was in 2009, meaning a 5 per cent growth rate now is around as impactful on global GDP as a 10 per cent growth rate was then. If China slows sharply further, we expect commodity exporting countries and emerging Asian economies to be hit hardest. There are comparatively fewer financial market and trade linkages between China and Europe or the US, meaning growth in the largest developed economies should be more insulated. 

Australia’s annual economic growth rate accelerated to a 1½-year high of 3 per cent in the December 2015 quarter, buoyed by increased Government investment and consumer spending. These growth drivers however do not appear overly sustainable. Indeed, the pick-up in consumption spending appeared to be driven by reduced household savings. Wages growth is around a multi-decade low with little sign of picking up. Although employment growth has picked up, it remains sub-trend and confined to the areas of health, education and tourism, largely reflecting a lower Australian dollar. Outside of this, surveyed business investment intentions are for further declines in the coming 18 months. This, together with falling mining investment, weak commodity prices and an inevitable peak in housing investment, leads us to believe the RBA might need to cut rates further in 2016. 

The overall effect of the above underpins our central forecast of no rapid deceleration in global growth this year. We don't think we're facing immediate prospects of a recession in developed economies (where the vast bulk of our investments lie). However, the risks to the outlook, particularly regarding China, global debt and geopolitics have not abated. With our central forecast for uninspiring growth and with risks skewed to the downside, we are comfortable holding a little more cash than normal in the portfolio. However, around this structural position, we have recently taken advantage of price falls in equities to add risk in this asset class. As always, we continue to monitor the market environment and asset valuations, and adjust the portfolios that form QSuper Lifetime and the ReadyMade options accordingly.

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 and you should get professional advice before relying on this information.
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