In this week’s bulletin:
- World leaders in Davos scrutinise the health of the global economy.
- Loose monetary policy creates conditions for a sustained recovery.
- The World Bank urges emerging markets to pursue investment and output.
- Global equities assess mixed economic data and the Fed’s bond-purchase taper.
‘The Magic Mountain’
Up in the mountains around Davos must be a fine place to feel free and reflect upon the trials and tribulations of the teeming mass of mankind below. The World Economic Forum (WEF) and global business and political elites, as is their perennial habit, are heading this week for the Swiss resort to do just that, and engage in a strenuous bout of elevated pondering on the planet’s future. This year’s Alpine bill of fare will dwell on weighty matters such as wealth, poverty and economic growth with the usual aim of trying to make the world just right.
Much of this year’s earnest diagnosis of the health and ills of globalisation and how it is reshaping the world is scheduled to focus on the developing economies. Some in the investment community are sceptical about what is on offer for investors from the economic march of these emerging markets, whether Brazil or Russia, Indian or China, the BRICs, or those of the latest acronym, the MINTs – Mexico, Indonesia, Nigeria and Turkey. The argument runs that the lower growth characteristic of developed economies offer better historical returns for investors over the expanse of decades or a century; while rapidly developing nations – such as China in recent decades – are necessarily blinkered in the pursuit of growth at the expense of shareholder profit and returns.
It’s a conveniently reductive perspective that clears the need to embroil investment decisions in on-the-ground details, such as the level of state control of business, regulatory conditions or the rule of law. However, long-term investors will know that the economics and the governance of the BRICs, MINTs or any other emerging market, with or without an acronym, matters. Investments, whether long- or short-term, are not made in an economic, political or social vacuum. A long-term approach to investing will take account of this wider arc, including the broader questions of demography and wealth distribution favoured at Davos. Investors should pursue value but a well-allocated and carefully selected portfolio will also attend to the big picture – even if not from the rarefied heights of the Swiss Alps.
World leaders and wealth creators in Davos this week will focus on the widening gap between rich and poor, which a WEF survey suggests is the biggest risk to the world in 2014, despite the signs of global economic recovery. The survey of global business and politicians warns that income disparity and related social unrest will increasingly influence the shape of the world economy in the next decade. It warns of a worldwide “lost generation” who came of age after the financial crisis and lack jobs, skills and opportunities.
More of the street protests and social unrest seen from Thailand to Brazil could result from this widespread frustration. But, as the former student of the London School of Economics and enfant terrible of the 1960s, Sir Michael Jagger, has pointed out, the recent troubles on the streets of, for example, Rio de Janeiro have a direct link to the ferment of 1968 with students and the young middle-class-to-be wanting more social mobility, opportunities and freedoms. Or, as WEF chief economist Jennifer Blanke comments: “Disgruntlement can lead to the dissolution of the fabric of society, especially if young people feel they don’t have a future.”
The WEF also articulated an increasingly commonplace argument that the monetary stimulus policies that have stabilised and revived economies have had little impact on the poor, the unemployed and the younger generation. (The survey also suggested that young people were graduating from “expensive and outmoded” schools and colleges with high debts and the wrong skills, while in developing countries around two-thirds would not reach their economic potential.) Is there a generation of young people – who, for many, are the raison d’être for saving, investing and creating wealth – heading into a world in which, half a century after the wave of liberal change in the West, there is no satisfaction?
We’ve consistently argued, as have other proponents of long-term investment, that ultra-loose monetary policy is not a panacea for the ills of the global economy and financial markets. But quantitative easing (QE) and accommodative polices have been an effective shelter to encourage favourable conditions for all, including investors, in the aftermath of the financial crisis. The growth of the US and now the UK economies, followed by Japan, as well as the strong rally for global equity markets last year – the MSCI World index rose 24% last year – are testament to the effectiveness so far of this unprecedented experiment in monetary policy.
Certainly, those with the means to invest or to retain their investments in recent years have done well, particularly in the equity markets since 2008–2009. And there is no doubt that many, whether the young or the less advantaged, feel they have not benefited yet from this revival of fortunes. But low interest rates that have been the handmaiden of QE have been to the advantage of borrowers and the less well-off; and to the personal financial detriment of savers and those with cash wealth. The goal of unconventional monetary policy is to induce economic recovery; and from that stems the desired, virtuous cycle of more investment, more employment, more output, more wealth and more spending and consumption.
In the meantime, global leaders continue to mix optimism with caution, particularly over the threat of deflation in Europe. Policymakers have one eye on Japan’s economy – moribund since the 1990s, which its government is finally reviving with its massive QE programme – for a demonstration of how deflation can erode consumption, investment and wealth. Last week, Christine Lagarde, managing director of the International Monetary Fund, noted in Washington that the recovery is still fragile, although “optimism is in the air” for growth. “If inflation is the genie, then deflation is the ogre that must be fought decisively,” she warned.
Rest and recuperation
Encouragingly, the World Bank last week also gave its verdict on the state of the global economy as showing signs of steady growth this year. The Washington-based institution forecast global growth of 3.2% in 2014, which is 0.2% faster than previously expected as economies, including those of the US and UK, regain their footing. Global growth at that level would mark the strongest expansion since the 4.3% growth in 2010. The bank said the world economy grew just 2.4% last year.
The forecast added that richer countries appeared to be “finally turning a corner”. In the developed nations, the drag from fiscal consolidation and policy uncertainty will continue to ease, it suggested, with growth expected among these richer nations to average 2.2%. The US economy is projected to grow by 2.8% in 2014, from 1.8% last year; the eurozone is expected to grow 1.1% this year after two years of contraction.
Emerging markets were urged to pursue the virtuous cycle of investment and output. Although 2014 growth is forecast to rise for these nations to 5.3% from 4.8% last year, Brazil is slowing to 2.4% from 4% and China to 7.7% from 8%. “Growth appears to be strengthening in both high-income and developing countries, but downside risks continue to threaten the global economic recovery,” said World Bank president Jim Yong Kim.
The big challenge for emerging markets remains the effect on capital flows of the US Federal Reserve’s reduction of its monthly bond-buying programme and when it starts to raise interest rates. The fear is of a further retreat of capital back to US markets like that following the Fed’s signal last May that an exit from QE was under consideration. If the adjustment to tapering proves disorderly, financial flows to developing countries could decline by as much as 80% for several months, the World Bank warned.
Vulnerable developing economies include those with short-term or foreign debt that forms a large proportion of overall debt, or where credit has been expanding rapidly in recent years, the World Bank adds. Last year Deutsche Bank floated a new acronym to denote those countries most prone to current account and fiscal deficits: BIITS (Brazil, Indonesia, India, Turkey and South Africa); also known as the ‘fragile five’. Fund manager Schroders has since dispensed with the acronym and just identifies the taper-sensitive countries that rely on outside finance with short-term financing needs as the fragile five plus Hungary, Chile and Poland.
However, the Fed has committed to an incremental taper, while an orderly QE exit is as vital for the US as it is for the rest of the global economy and markets. Reassuringly, the World Bank suggests that world economic growth should counteract the impact of any increase in interest rates on developing economies. The World Bank and the IMF are right to urge emerging economies to bolster currency reserves, balance sheets and competitiveness. However, it is worth remembering that although growth and structural reform are good for stable markets and long-term investments, the benefits take time to translate into rising stock prices.
Meanwhile, global equities rallied after an initial retreat as markets assessed the significance of mixed US economic data for the pace of the Fed’s bond-purchase taper. The S&P 500 index retreated 0.2% over the five-day period to close on Friday at 1,839 points. The index lost 1.2% last Monday amid concerns about valuations, following disappointing US job figures and uncertainty over the impact on the taper programme. Strong US retail and inventory figures, however, helped overturn losses during the rest of the week.
Despite the uncertainty on Wall Street, on the other side of the Atlantic, equity markets enjoyed strong gains as confidence mounts in the economic recovery. The FTSE 100 index rose 1.3% over the week to 6,829 points, which was its highest close since May last year. The FTSEurofirst 300 was up 1.8% over the week to perch at a five-year high of 1,345 points on Friday. In Tokyo, however, the Nikkei 225 reflected the uncertainty in the US, with the index losing 1.1% over the week to close at 15,734 points.
Markets this week will assess more data for signs of recovery across the advanced nations. UK labour market figures are due out on Wednesday, with the Bank of England committed to review interest rates when the level of unemployment reaches 7%. With economists expecting a fall in the number of jobless to 7.3% for November, markets will look to the Monetary Policy Committee’s (MPC) January minutes for signs of an early rise in interest rates or, amid the faster-than-expected recovery, an adjustment of the unemployment target. It is widely expected that the MPC will refrain from any suggestion that interest rates will rise in the near future.
Health and efficiency
Alongside fears of deflation and the impact of the Fed’s reduction of QE, there is longer-term economic concern, despite the recent signs of growth, over lower levels of global productivity and the effect of this on business performance, profit and investments. Last week the US think tank, The Conference Board, reported that global productivity weakened for a third year in 2013. The think tank’s broader measure of total factor productivity, which reflects the efficiency with which capital is used, is also down.
Davos will dwell on how a slowdown of productivity and inefficient use of capital could frustrate hopes to improve living standards and to close the wealth gap between nations. Efficient productivity can determine a country’s living standards and economic growth, as the benefits of its more profitable labour lifts the rest of the economy. Fortunately, a healthy economic outlook and increased employment will power global growth in 2014. But labour and capital efficiency are crucial for the sustained growth of businesses, markets and returns.