SUMMARY ASSET ALLOCATION
In April, global equities rose modestly, in both US dollar and euro terms. On a global aggregate basis, bonds posted similar returns to equities. Both in equities and bonds, Japan stood out, with assets returns supported by yen appreciation. Further spread narrowing, particularly on high-yield corporate issues, also helped global aggregate bond indices. Obviously, markets were relieved that the US economy is not heading for recession and that the Chinese economy has shown signs of stabilising. However, given generally modest GDP growth, low inflation and low earnings growth, we think many risk asset markets have become complacent. Our asset allocation is quite defensive, with underweights in equities, emerging market debt in hard currency and commodities.
Growth divergence, will it last?
Growth momentum diverged in the first quarter of 2016. Growth in the US economy was barely positive. A frugal consumer, falling business investment and drags from net trade and inventories kept GDP growth at a marginal 0.5% QoQ annualised. In non-annualised terms this is only 0.1%. In the eurozone, growth accelerated to 0.6% QoQ (non-annualised). This was positive as growth had slowed over the course of last year. While momentum in the eurozone was stronger than in the US in the first quarter, the eurozone has clearly lagged the US this cycle. The US had passed its pre-crisis peak already in the third quarter of 2011, but it took the eurozone until the first quarter of this year to recoup all the losses. In China, growth slowed marginally to 6.7% YoY, which is right in the middle of the government’s target range. Japanese growth data has yet to be published, but the country may have entered another technical recession with two consecutive quarters of falling GDP.
Will this divergence continue? Only to some extent, we think. The US economy should rebound from the weakness in the first quarter. Consumers’ frugality seems out of line with robust fundamentals including income gains, more jobs and rising house prices. This rebound may be constrained by lingering weakness in the business sector, which is suffering from high inventories and the relatively strong US dollar. We think it unlikely that the eurozone will continue to grow at the first quarter’s pace. Domestic demand should be supportive, but tailwinds such as falling oil prices and a depreciating currency are fading. Leading indicators have recently moved sideways.
While markets were generally relieved by the recent Chinese data, we think there are only tentative signs of improvement. Growth slowed to 4.5% QoQ annualised in the first quarter, which is the slowest pace in the five years that this data is available for. Adjusted for inflation, retail sales grew in March at the slowest pace in 12 years. Corporate bond spreads have widened recently as an increasing number of companies has defaulted. Sure, the economy may rebound on the back of monetary and fiscal stimulus, but the imbalances (surging credit, overinvestment and overcapacity and perhaps another housing bubble) are only worsening.Download to read more