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Portfolio > Economy & Markets

Trends Point to Growth & Stability

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Developed nations are showing renewed signs of stability in output growth and employment, according to recent data from the International Monetary Fund. Meanwhile, the emerging markets of the world have hit an important milestone: Their combined gross domestic product now represents more than 50% of global production, a recent IMF report states.

These trends are good news for companies selling products and services worldwide—and for their investors. As economic stability continues over the next few years, both corporations and consumers are expected to buy more oil, for instance, as well as more pharmaceuticals.

The U.S. Energy Information Administration has estimated that global consumption of oil grew by 1.2 million barrels per day in 2013 and averaged 90.4 million barrels per day for the year.

The EIA expects global consumption to grow by 1.2 million barrels per day again in 2014 and then jump by 1.4 million barrels per day in 2015. It also projects that global-oil-consumption-weighted real GDP, which increased by an estimated 2.3% in 2013, should expand 2.9% this year and 3.4% in 2015.

The global pharmaceutical market, as tracked by the International Federation of Pharmaceutical Manufacturers & Associations, could reach nearly $1.2 trillion by 2016—up from about $960 billion in 2011. Plus, the leading emerging countries should account for 28% of global spending on pharmaceuticals in 2016 vs. 12% in 2005.

‘Great Moderation 2.0′

What factors are producing today’s rosy economic picture? The answer begins with the general stability of many major economies from 1984-2008, referred to as the “Great Moderation” by some experts; it featured low variability in both real GDP growth and inflation. This period, of course, did include some bumps but was dominated by consistent, moderate expansion.

Next came the Great Recession of 2008-2009. But some five years later, the world’s developed economies seem to be experiencing “Great Moderation 2.0,” according to economists John Normand at JP Morgan and Dominic Wilson of Goldman Sachs.

Today, growth volatility in the main industrial countries is the lowest it has been since 2007, Bloomberg calculated in early May using IMF data. Plus, volatility is about half of what it was for the 20 years starting in 1987.

Furthermore, a risk measure that relies on options and anticipates movement in equities, currencies, commodities and bonds is at its weakest level of almost seven years, the news group says.

The Group of Seven nations’ variability in employment growth should decline to 0.4% in 2014 vs. nearly 3% in 2010. This figure averaged 0.8% in the 20-year period ending 2007, according to the Bloomberg analysis of IMF statistics. It hit a high of 1.7% in 2009 but dropped to 0.1% in 2014.

The Bank of America Market Risk Index fell to negative 1.14 on May 2, which is its lowest level since mid-2007, the news group says. At the same time, JPMorgan’s Global VX Volatility Index has revealed the lowest fluctuations in the currency market for the past seven years.

This certainty is keeping consumer and investor confidence at high levels in the major economies. But those in the emerging markets have plenty of reasons for optimism, as well, as they become the dominant GDP muscle in the global economy.

Wither Volatility?

A feature of 2014 has been the degree to which volatility has fallen across the financial markets — whether equities, bonds or foreign exchange. For some, this is an opportunity “to take a breather, after several years of challenging conditions,” explain Ian Harnett, David Bowers and Zahra Ward-Murphy of Absolute Strategy Research in a May report.

“Today’s low market volatility reflects the new macro-economic reality,” the authors noted.” In other words, the low volatility in no accident.

“Pessimism about the ability of markets to sustain low volatility often ignores the fact that the economics have also calmed down! Persistent low interest rates and a policy focus on delivering consistently rising payrolls have helped see the dispersion of economic forecasts fall across most major economies, helping validate low volatility,” the experts shared.

Greater policy certainty, they add, creates more economic certainty and pushes market trends to persist longer than anticipated. And, at least for now, issues that have concerned investors and policy-makers alike, such as excess leverage and extreme valuations between sectors, stocks and assets, have yet to emerge.

Global Dynamics

Some experts are focused on the economies of the United States and China, which are neck in neck this year when it comes to having the world’s largest economy. But there’s another race that’s already been won: Emerging markets have overtaken developed economies in terms of having the largest share of global GDP.

“This is clear from new IMF data released in April. Clearly, both investor perceptions about and allocations to EM continue to lag far behind EM’s rapid fundamental advances,” explained Jan Dehn, head of research for Ashmore Investment Management.

“This is true in both equities and fixed income, but especially in fixed income, where allocations by many investors lag weighting implied by simple GDP weighting by as much as 10 times,” the London-based researcher noted in a report in early May. “This suggests that EM’s long-term technicals remain extremely strong.”

According to the IMF’s April 2014 “World Economic Outlook” analysis, the emerging markets’ share of global GDP hit 50.4% in 2013, up from 31% in 1980, after adjusting for purchasing power parity (or PPP).

Emerging-Markets Boom

These economies increased their share of global GDP by an average of 0.6% per year over the past 33 years, Dehn notes. And there’s no end in sight.

“Interestingly, the IMF expects EM share of global GDP to increase at an ever faster pace going forward. According to its forecasts, EM’s share of global GDP will grow by an average of 0.7% per year from now until 2019 to reach 54.5%,” the ex-World Bank consultant explained.

Portfolio allocations to these markets, though, on the part of most central banks, sovereign wealth funds, public and private pension funds, endowments, foundations and retail investors, are “massively below what would be implied by simple GDP weighting,” he stresses.

As for major emerging markets, the expert points to positive conditions in China, where manufacturing is stabilizing. Official manufacturing, as measured by the Purchasing Managers’ Index, or PMI, was 50.4 in April, up from 50.3 in March, Dehn says in his recent report, entitled “Move Over Please!”

Though the Ashmore expert does not expect a substantial pick up in manufacturing or growth—as China transforms its economy from export to domestic-demand led—the country’s policies should produce growth sustainability “once inflation returns in the world’s QE economies and EM currencies strengthen by virtue of the strong external balances,” he explains.

“No country in the world will be more impacted by this change than China,” Dehn stressed.

Meanwhile in India, the Finance Ministry has said it will move to makes its capital market more “investor friendly” after the current elections. “When viewed in conjunction with ongoing reforms of the Indian banking system, our reading of the tea leaves suggests an opening of the Indian domestic bond market to foreign investors in the not-too-distant future,” the expert said.

And there’s more good news for countries like South Korea, which recently reported stronger-than-expected growth data: April exports rose 9% year over year vs. the anticipated 5.5%.

In Mexico, Dehn points out, further reforms of the energy sector should be forthcoming. “Once the legislation has been approved, we expect to begin to see investment in the sector with material upside accruing to Mexico through the medium and long term,” he added.

In terms of where EM economies stand vs. their more-developed counterparts, the analyst highlights another significant statistic: Portugal’s debt-to-GDP ratio is 130% compared to an average net-debt-to-GDP ratio of just 34% across all 165 emerging economies.

China’s Story

China is currently going through a period of economic reorientation, which does entail a shift in its growth pace, but also the possibility for longer-term stability and positive reforms, according to at least one portfolio manager. “China will sacrifice some headline growth in order to focus on de-leveraging and reforms,” said Emerson Yip, lead portfolio manager for the JPMorgan China Region Fund, on a call with investors in May. The country’s leadership, he adds, views “quality and sustainability as [its] over-riding objectives.”

Yip acknowledges that the jury “is still out” on its reform process, making it important for investors “to approach this [market] with a healthy, deep dose of skepticism.” Still, he adds, China’s economic and political team “seems ready to tackle the tougher tasks on both fronts” of reforms.

“If we judge China’s leadership by the actions and words [focused on curbing] corruption and the other reforms that have been undertaken … in banking, currency markets and the brokerage space—and we see more to come—there are signs of commitment and success as strong as any in recent memory, dating back to the ‘70s,” Yip said.

China’s exports and imports unexpectedly rose in April. Overseas shipments increased 0.9% from a year earlier, for instance. Imports gained 0.8%, giving the county a trade surplus of about $18.5 billion. The country’s adjusted export growth improved to 6.7% in April from 3.5% in March. Exports to the U.S. rose 12%, according to Bloomberg data, while shipments to the European Union expanded 15.1% and to South Korea by 13.5%.

Still, the pace of the country’s economic growth is slowing, as it has been since 2007. China’s 10-year average GDP growth rate is 9.9%, while GDP growth was 7.7% last year. This figure is expected to be 7.5% this year, JPMorgan analysts note. “We say you want to look at slowing growth as a time to pick up winners,” said Yip, “as a sustainable economic-growth pace is sought.”

What’s happening in the country’s economy? “China is transitioning from being the world’s factory to being the world’s consumer, with longer-term implications,” Yip said during a question-and-answer period with investors. “In the long term, China’s rise should benefit everyone, including its reforms and sustainability objectives,” the portfolio manager added.

The JPMorgan China Region Fund improved 12.6% last year vs. 5.1% for its benchmark (which consists of the MSCI Golden Dragon Index, 80%, and the China Securities Index 300, 20%). In the first three months of the year, the S&P 500 improved about 1.8%, while the MSCI Taiwan Index rose 1.1%. The MSCI Hong Kong Index, however, fell 3.4%, and the MSCI China Index declined 5.9%.

Consumers in Greater China are expected to “stay resilient,” says Yep, who adds that JPMorgan has an Overweight stance on equities tied to sectors like Macau gaming, Chinese autos and China smartphones/Internet.

Demand for smart phones in the region should hit or exceed roughly 400 million units this year, up from about 300 million last year. Auto demand totaled about 16 million vehicles in 2013, according to estimates, up from 14 million units in 2012. Year-over-year growth rates for car sales, including SUVs, are put at 15% to 20%. Overall retail sales are growing at about 20% year over year and are up from late 2013.

In addition, JPMorgan’s estimates indicate that nearly 60 million tourists visited Hong Kong in 2013, the majority from China. The average rate of tourist visits to the island is growing about 13% per year, while the growth of tourism from China is averaging 17% per annum.

Digital Flows

Even with fluctuations in certain sectors and economic measures, the pulse of global flows that connect the world’s economies is anticipated to remain rapid, a recent study by the McKinsey Global Institute says. Today, the movement of goods, services, finance and people “has reached previously unimagined levels. Global flows are creating new degrees of connectedness among economies—and playing an ever-larger role in determining the fate of nations, companies, and individuals; to be unconnected is to fall behind,” says MGI’s report “Global Flows in a Digital Age.”

These flows totaled $26 trillion in 2012, accounting for 36% of global GDP, 1.5 times the level they attained in 1990. Plus, the consulting group expects global flows to triple over the coming decade, “powered by rising prosperity and participation in the emerging world and by the spread of the Internet and digital technologies”.

In fact, MGI estimates that global flows could reach between $54 trillion and $85 trillion by 2025. The group finds that nations with a larger number of connections in the global network of flows increase GDP growth by up to 40% more than less connected countries do. “The penalty for being left behind is rising,” the report stressed.

Investors, too, have been trying not to be left behind, and portfolio managers say such strategies are prudent. Emphasizing the upside potential of the global economy’s recovery, David Eiswert of T. Rowe Price pointed out in an April report: “Developed market valuations remain reasonable, with parts of emerging looking inexpensive.”

“As we move on from the ‘response’ phase of the [market] cycle and into the ‘improvement’ phase, the drivers of equity returns will be different and arguably more complex,” said the manager of Global Focused Growth Equity Strategy. “These remain exciting times for global equity investors, however.”


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