At a recent series of adviser briefings in Melbourne and Sydney, Epoch Investment Management’s CIO, Bill Priest, outlined a number of macroeconomic themes affecting global markets.
Quantitative easing (QE) remains a global phenomenon as every central bank of consequence is engaged in some form of monetary accommodation.
Global growth is showing some signs of improvement, albeit at a modest pace.
There is modest optimism in Europe as unemployment appears to have peaked at around 12%. The European Central Bank (ECB) remains interesting because its QE program has been tapering since 2012. Since then, bond yields in countries such as Spain and Italy have fallen considerably relative to Germany, and stock markets have advanced. The perception is that the ECB will remove any potential liquidity risk.
Germany has been one of the huge beneficiaries of the Eurozone, on the other hand. If they had to resort to a currency of their own, it would most likely be about 10-20% higher, damaging their export business.
Nonetheless, the risk of deflation is still present in virtually every European country except Germany. We have reached the point where we will need to see the positive effects of monetary policy make its way into the real economy or QE might start to look like the emperor’s new clothes.
China’s attempt to reform its economy from mercantilist to consumer driven, if successful, will result in slower growth. The goal is to evolve into a consumer-led economy. The shift away from an investment and export led economy will result in fewer employees per dollar of GDP. We have seen estimates of under 8% for this year and would not be surprised by a growth rate that is even less.
A lack of transparency makes China’s financial system an enigma. We do know there is an enormous amount of bad debt in the system. China does currently have the reserves to take care of this problem, but they have created a substantial amount of debt relative to GDP.
Emerging markets that rely on external funding are going to find themselves in trouble. QE essentially created a “risk on” environment, and provided much liquidity as investors searched for higher yield. As this begins to unwind and rates begin to rise, capital is exiting those countries because investors do not have to tolerate the additional risk.
Looking ahead, it is clear the risks associated with low growth are diminishing, however revaluation opportunities are already priced into many markets. Profitable growth and shareholder yield will become the important drivers of equity returns. The emphasis should be on companies with pricing power due to market structure, capacity constraints or demand inelasticity. Investors should focus on companies with the ability to improve capital allocations.
Damien McIntyre is Head of Distribution, Grant Samuel Funds Management. GSFM distributes Epoch’s investment products to Australian clients.
