Global Equity Investment: Portfolio Positioning for a Multi-Low Environment - Economic & Financial Market Background

It was interesting to note that the OECD in its latest bi-annual Economic Outlook placed the blame for stalling world growth at the door of eurozone policy makers. Along with those of most other commentators, OECD forecasts still assume that the EU sovereign debt and banking sector crises will be contained, but ominously warned that "alternative scenarios are possible, and may be even more likely than the baseline…. (and)…. in view of the great uncertainty policy makers now confront, they must be prepared to face the worst". In summary, a failure to restore confidence in the eurozone and/or excessively tight fiscal policy in the U.S. are noted as key risks that could lead to a far gloomier outcome for the global economy.

Fortunately for global growth, U.S. activity has recovered well from its oil price/supply chain-induced first half slowdown. Underlying private sector demand growth during that period was far higher than suggested by the headline GDP figure and, even though Q3 was revised down to 2.0% from 2.5%, private sector final domestic demand still contributed a very solid 3.1% to the total. Forecasts for Q4 have recently crept upwards with a continuing stream of data exceeding expectations.

The recent faster pace of growth is welcome news but partly reflects recovery from prior temporary weakness and, relative to what is needed to sustainably reduce unemployment while allowing for fiscal consolidation, it is still inadequate. Forecasting into the New Year is also exceedingly difficult as there is still considerable uncertainty over the extent of U.S. fiscal tightening next year (tax cut/unemployment benefit extension?) and the outlook is for a relatively subdued expansion phase at best.

Eurozone GDP forecasts continue to be slashed. In reality, the likely outcome is a complete unknown but the escalation of the sovereign debt crisis, now "core" countries, has already led to a high probability of the region's economy falling into recession in Q4 and the main arguments revolve around just how deep a recession unfolds next year. Confidence-building action by the EU authorities is urgently needed. Whether it will be an improvement on previous "comprehensive" plans can but be hoped for although experience has shown the difficulty of producing a credible package that effectively stabilises financial markets.

As noted above, economies are also slowing elsewhere, with the details of the U.K. Q3 GDP report undermining the headline 2.0% p.a. growth rate. Real household expenditure (62% of GDP) contracted for a fifth consecutive quarter while recent forecast revisions by the Office for Budget Responsibility, accompanying the Chancellor's Autumn Statement, indicate the government's fiscal targets slipping by two years. At least one negative quarter of GDP growth appears in store in the near future and the U.K. economy may, at best, only just avoid slipping back into recession.

Activity in the Far East is also easing with slowing export growth affecting much of the region. Japan has ended its 'V'-shaped GDP rebound--plus 6% in Q3--but will benefit from reconstruction spending next year, while the authorities in China are already beginning to fine tune monetary policy following recent PMI weakness and an on-going slowdown in the property sector. China and other Asian economies, along with a contained eurozone crisis, are key to global growth prospects next year.

Editor’s note: The next issue will focus on our views on asset allocation.