Quarterly Investment Strategy
A politically heated final quarter
Whatever the glimmers of improvement, the global economy remains well short of reaching “escape velocity” – a level of growth that it could sustain without repeated doses of monetary or fiscal assistance.
In the US, late- to end-of-cycle economic conditions limit the Federal Reserve’s (Fed) leeway to hike rates and put pressure on the Treasury to deliver more fiscal support.
While admittedly not impressive, Eurozone economic trends are defying doomsayers with consumption in particular at its strongest since 2010.
September saw the surprise decision by the Bank of Japan to adopt yield targeting, in the hope of improving the banking sector’s ability to extend credit, while allievating the shortage of Japanese government bonds.
A more dovish Fed, the ongoing rebalancing in oil markets and upside surprises in Chinese macro data have so far supported our positive stance on emerging markets, but the US presidential election is a risk.
For now the “lower for longer” rates axiom remains in place, warranting continued yield-chasing in credit, real assets and high dividend stocks – such investments should be calibrated and diversified according to the risk appetite of each portfolio.
From an economic and financial viewpoint, the next months should see little change. Global growth has steadied, helping abate deflationary fears, but remains very much dependent on monetary and fiscal stimulus. Politically, however, the final quarter of 2016 could prove explosive – event risk is prevalent across Europe as well as, obviously, in the US.
Recent global leading indicator readings have been relatively constructive. World output and trade growth appear to have stabilised and there are even some signs of rising prices. Emerging market economies have definitely reasserted themselves over the past few months while, amongst developed economies, and perhaps somewhat surprisingly, European countries have continued to display the most favourable dynamics.
Weakening trends in the US and Japan, the two largest developed economies, are obviously a concern. More generally, demographic, productivity and excess capacity headwinds continue to constrain aggregate demand growth. With no urgent need for additional capacity, companies are not in a mood to increase their spending. Slower labour force growth means less incentive to build new factories, shopping malls or office towers. Decreased household formation has also curbed the demand for new homes.
As such, whatever the glimmers of improvement, the global economy remains well short of reaching “escape velocity” – a level of growth that it could sustain without repeated doses of monetary or fiscal assistance. Policymakers around the globe will continue to embrace reflationary policies in a bid to quell growing populism and protect their jobs. Easy money is here to stay for some time, notwithstanding a probable timid rate hike by the Fed in December, but the fiscal measures being taken in a number of countries (namely China, Japan and the UK) suggest that monetary stimulus is no longer the only game in town when it comes to supporting the economy. In fact, central bankers appear to be acknowledging that negative rates have adverse secondary effects on banking sector profitability (hence economic growth) and seem determined to mitigate their impact.
Every downside risk is thus likely to be met by a policy response. And such risks are plentiful as we look to this quarter’s political agenda. The new UK government will deliver its autumn statement, providing the first tangible signs of the economic model that it envisions in the aftermath of the “Brexit” vote. This will be preceded by heated elections in the US and a constitutional vote in Italy that is nearly as critical as the British referendum was three months ago. And then of course will be the build-up to elections in Spain, Germany, France and the Netherlands, where the status quo has generated unhappy citizens, who would all but welcome increased trade barriers.
All told, our outlook is one of continuity rather than system reboot. Political risk is prodigious but central bank policy outside of the US will remain expansive and fiscal policy is set to become more supportive. Such a scenario of “low but stable” growth, with reactive policymakers, implies continued downward pressure on the cost of capital, in turn allowing financial assets to become ever more expensive.
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Note: Unless otherwise stated, all data mentioned in this publication is based on the following sources: Datastream, Bloomberg, Lombard Odier calculation.
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