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06 September 2010

US economic growth slowing faster than expected Austerity measures increasingly visible in the US at a state level Europe must not be complacent and could face similar problems Emerging markets may face food inflation Neil Dwane, Chief Investment Officer (CIO) Europe at RCM, a company of Allianz Global Investors, reflects on the global outlook as the world economy gears up for autumn. Economy is slowing “The downgrade of the Q2 GDP data demonstrated that the US economy is slowing much faster than policymakers and investors had expected. Something has been happening in the US economy that has effectively stalled the strong recovery that policymakers had been hoping for. “It is quite clear inside the US that, apart from the activity being undertaken by President Obama and Ben Bernanke, the US states themselves have already entered quite a serious degree of austerity. We are reading about policemen losing their jobs, schools and hospitals being closed and in California they are now paying you with IOUs that are only worth 88% of the dollar bill written on the cheque when you take them to the bank. “We are seeing the US housing market relapsing badly in spite of the fantastic work that the bond market has done with its rally during the summer, reducing the yield on 10 year bonds to 2.5% and making mortgage renewal more affordable as a result. But, clearly an awful lot of people cannot afford to refinance with the latest data from the US suggesting that one in four mortgages in the US exceeds the value of the property on which it was written. The US housing market, which is normally one of the cyclical parts of the economy that leads an economic recovery, is clearly now one of the anchors that is slowing this economy. “We know that at the moment there will be no reinstatement of the Bush tax cuts, which will give the US a headwind of 1.5 to 2% of GDP next year. However Ben Bernanke has reiterated that the US will grow at 3 or 4%. We are at present trying to work out what components of the economy will provide this growth, given the weak housing market and fact that unemployment is approaching 10%, which is likely to prove to be a drag on any recovery in consumer spending. European countries expect a wave of austerity “Moving away from the US, we have had a more friendly summer in Europe, as the sovereign debt crisis seems to have faded and the Euro has recovered, together with a strong export-driven recovery in the German economy. However, what we do see in Europe, whether it’s with the Greeks or the British, is that austerity is expected to arrive at the latest in 2011. We should therefore carefully monitor developments over the next 6-12 months, as the austerity wave which we see in the US at a state level could well spread to Europe too. “Worryingly, when one looks to the future, we see that the euro was not weak enough nor for a long enough period to either sustainably boost German exports or to improve the competitive position of the weaker Southern European countries. Countries like Ireland are beginning to show how hard it is, even if you are putting the most effective economic policy in place, to help the economy to recover. They are truly in a paradox of thrift at the moment where the more they save and implement sound economic policy, the more their economy continues to shrink. This may be a foretaste of what the future holds for Spain, Italy and for Greece. US and China slowdown has knock-on effect on Japan “Over in Japan we have seen growth stalling and deflation returning to haunt the economy. The growth is stalling because the US and China are slowing down and Japan is struggling with an ultra strong currency. The heartbeat of the Japanese economy, the exporters – the Toyotas and the Sony’s of this world, are now struggling with very serious currency headwinds which is affecting their economic performance. “Japan’s latest round of quantitative easing should show policy makers around the world that if you don’t implement sufficiently large quantitative easing policies, the market is likely to simply ask for more. Clearly, given the poor performance of the Japanese economy and its stock market for the last 15 or 20 years, it is not reassuring for Chinese policymakers that the markets could fall so badly overnight on the first day of quantitative easing. China focuses on consumer side of market “Turning to China, now the world’s second largest economy, it is trundling slowly along at its target rate of growth of 8%. At the moment, it doesn’t want to re-stimulate its economy because it is concerned that it has over-stimulated the property areas of the main coastal cities and it is now seeking to invest in the underdeveloped inland regions instead. China is still trying to move from being a purely export-led economy, to a domestic-consumption driven economy; the recent BHP Billiton bid for Potash in Canada is a reflection of the future growth of the Chinese middle class, with changing tastes and a desire to consume more meat, based on the fact that cattle consume large amounts of grain. A two-tier global economy “We can still see a two-tier global economy in place, with the over-banked, overstressed developed world continuing to struggle to make headway, whilst the emerging markets likely to continue to deliver reasonably robust economic growth. “The problem in emerging markets may well turn out to be food inflation. We are increasingly concerned about the difficulties with drought which Russia has experienced this summer which has led to a drop in the wheat harvest there, and the tragic monsoon difficulties in Pakistan, which has also hurt food production in India. Irregular weather patterns around the world could well lead to rising food prices which we think may cause some concerns for inflation in emerging markets. “In terms of where attractive opportunities can be found in this current, uncertain climate, we believe that European equities offer investors good investment opportunities. European companies with strong business models are well-placed to benefit from strong market positions as well as exposure to emerging markets. Dividends are very attractive relative to other parts of the corporate structure (for example, credit) and investors are well-placed to benefit from both capital returns as well as a relatively high level of income, especially if there is no return to recession in the second half of 2010.” – Ends –

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