World Economic outlook - Strategy summary and global economic outlook 2012 : In 2011, global equities lost around 8% (as of the day of writing), while global bonds are up approximately 6%. In Q4 2011, both asset classes showed a marginally positive performance.
Regionally, US equities were almost unchanged over the year, while the more cyclical market in Japan is down almost 20%, similar to Europe. Global emerging markets ‘only’ lost 13%. In the bond markets, we find a similar regional ranking: US government bonds up around 10%, followed by emerging market bonds (up 7%), while Japan (up 3%) and the EMU (up 1.5%) are clearly lagging. In both asset classes (bonds and equities), Europe slightly outperformed in Q4, while emerging markets and Japan both underperformed.
What are the underlying forces characterising last year’s capital market developments? How will they develop going forward?
We think that global markets currently are facing three challenges that are interrelated and show different dynamics: firstly, we identify a structural headwind of lower growth in developed economies due to the necessary de-leveraging both of private and public sectors. As history shows, countries undergoing the process of debt reduction face a prolonged period of trend growth significantly below
the growth rate observed while leverage in the economy is increased. This is quite understandable, as the private sector no longer runs at extremely low or even negative savings rates; the public sector, too, needs to cut expenses and increase taxes in order to trim its debt ratios. We estimate that trend growth in developed economies will be around 0.5% lower compared to the years prior to 2007. While economic growth strategies in general may have a positive impact on economic activity in future, any growthenhancing structural reforms will only show their effect over a medium-term, multi-year horizon.
As a consequence of the ongoing de-leveraging and tighter fiscal policy, central banks have reduced rates massively and provided additional liquidity to the system. We expect real rates to be extremely low or even negative in years to come.
The cyclical weakness, which has been the second headwind for capital markets, is partially a consequence of the policy reaction described here. Tight fiscal policy is directly dragging down economic activity in developed economies. This could, at least to some extent, be compensated by strong demand from emerging markets. However, due to substantial capital inflows until mid 2011, emerging markets had to react by tightening monetary policy. Low interest rates have additionally added to speculative demand for commodities, thereby adding to inflationary pressure, in particular in emerging markets. As a consequence of monetary policy tightening, demand in emerging markets has slowed down.
The oil price increase, fuelled by initially strong demand from emerging markets, financial investments in commodities and political uncertainty in the Middle East, has worked as a tax on consumers in developed economies. In five out of six previous oil price spikes similar to the one we had in early 2011, the Western world fell into recession. In 2012, we think the developed world will face a hard landing as well.
Still, we are of the opinion that we can avoid a global recession. The private sector is cash-flow positive and, hence, is able to compensate for lower government spending. Admittedly, there are limits to driving down the savings rate, as the private sector is no longer able or willing to increase its leverage, as was the case in the mid 2000s.
Still, private-sector demand can dampen the slowdown. Monetary policy, too, remains highly accommodative. Real short rates are negative in most economies; central bank balance sheets are expanding via non-conventional measures. For instance, the ECB has just provided EUR489 billion over a period of three years to the EMU banking sector – more than enough to secure banks’ refinancing needs.
This should certainly lead to an improvement in lending conditions, which have started to tighten again since summer. (source http://www.allianzglobalinvestors.de )
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