Divergent and uneven global growth dynamics
The complexion of global growth is changing as major economic zones have embarked on a long and bumpy trip to address chronic economic imbalances. In China, a transition is underway from a credit fueled investment boom to a more consumer driven economy. In Europe, years of credit leveraging across the board masked a balance of payments crisis and an inept monetary union is now dealing with a political and a fiscal disunion. In the U.S., a 30 year credit leveraging cycle is coming to an end, with households and corporations being at a more advanced stage in the deleveraging process. Along this global rebalancing act to sustainability, financial participants are witnessing a tug of war between the deflationary forces of financial deleveraging and the reflationary forces of the global central banking system. Global growth should be expected to be uneven and as such, from an investment perspective, nimbleness and an open mind are needed in allocating capital.
As we can see below, recent G10 economic data have been lackluster. Mixed economic activity in Asia, weakness in Europe and a moderate U.S. growth profile are evident. From a cyclical perspective we are approaching mid-cycle and we are positioned for a late-cycle stage. Moreover, our current view is for global inflation expectations to remain in check, thus rendering Central Banks with some leeway to engage in further monetary easing. Apart from recent rate cuts in Brazil and Australia, our focus is on how active the Chinese monetary authorities will be as they transition their economy to a consumer driven model.
On the U.S. front, consumers are currently benefiting from low debt service payments and Q1 GDP witnessed increased final demand, mainly driven by autos. Moreover, we note that personal income and the personal savings rate have trailed in Q1. Therefore, labor market stability and income growth will be key in the coming quarters and our employment indicator still points to an improving labor market. As we highighted in recent articles, better visibility on the fiscal front is needed in order for corporations and households to perpetuate the business cycle.
On the housing front, we remain optimistic that the bottoming process is underway. Increased affordability and pressures in the rental market are likely to support house prices as the foreclosure pipeline gradually clears.
On the U.S. monetary front, the Federal Reserve remains highly accommodative. We note however that monetary policy alone is not a panacea for the U.S. economy. There are limits to its effectiveness and as the Fed Chairman stated recently, he is mindful of inflation expectations; thus guarding the Federal Reserve’s credibility. In addition, he pointed to Congress and fiscal policy as an area where action is needed in the very near future.
On the other side of the pond, we highlight the positive improvement in the European money supply, following the ECB’s 3 year refinancing programs. As a result of the sovereign/banking crisis, European monetary conditions remain challenged due to a lack of credit demand and as banks in peripheral Europe are not channeling credit in the real economy. Thus, we expect the ECB to override any inflation concerns and further ease interest rates by June. Lastly, we expect European leaders to place more focus on much needed growth initiatives.
Clearly, economic conditions in Spain and Italy are key to systemic stability. We note that banks in both countries have been critical buyers of their sovereign debt. Moreover, we highlight the cash hoarding at the ECB’s overnight deposit facility and the recent capital flight indications from the TARGET2 inter-banking payment system. Cross-border transfers from peripheral Europe to Germany is an ongoing issue and we wouldn’t be surprised if capital controls are put into place, in an attempt to protect the respective banking systems.
In conclusion, we continue to closely monitor the evolution of the global business cycle and its structural challenges. We maintain our balanced portfolio approach with a tilt towards income generating securities that offer cash flow and earnings visibility. Thus, we seek to harvest yield from MBS, preferred shares and dividend paying equities.
Christos Charalambous CFA
Senior Strategist
christos.charalambous@edgewealth.com
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