Strategy: Growth still trundling along the runway; no immediate take-off in view

10 Aug 2016


  • World economic growth: A lacklustre Q2
  • US GDP growth: Better after a second look
  • Europe: Life after the UK referendum
  • Central banks: Finally, one positive surprise
  • Asset allocation: Increased defensive stance

Financial markets have recently focused mainly on GDP growth in the developed economies and on hopes that further interventions from central banks may provide a positive growth and market impulse. It appears that global GDP growth in Q2 remained disappointingly low. Oil prices also weakened significantly. Many major central banks appear ready to provide further monetary policy stimulus this autumn, but we do not believe this will be sufficient to boost economic performance and we remain cautious on risky assets.


Global GDP data for the second quarter does not so far show the world economy gaining much traction. Among G7 countries, the UK posted the strongest Q2 growth. The first estimate of GDP growth in the eurozone suggests it slowed by half in Q2 compared to Q1, with member state data quite varied. One substantial drag was less buoyant consumer demand – retail sales stagnated in June and revealed a heavily slowing quarterly growth pace in Q2. There may be further downward revisions to eurozone Q2 growth estimates as June industrial production data for Germany and Italy was weak.

South Korea’s GDP growth rate accelerated in Q2, benefiting from government spending aimed at reducing the country’s dependence on export-driven growth. Developments in emerging markets were heterogeneous in July, but overall painted a picture of achieving little more than stabilisation. While higher government and infrastructure spending in Indonesia supported an acceleration in GDP growth, Mexico’s growth pace slowed. July’s emerging market PMIs were mixed: The services PMIs improved in all the BRIC countries except China, whereas the BRIC manufacturing sector PMIs indicated a continuing struggle in the face of weak world trade.


In the US, meagre headline Q2 GDP growth data prompted a prolonging out to mid-2017 of market expectations for a rate rise. The initial market reaction to the data appeared too complacent but the latest US labour market data corrected this. The US also published downward revisions to earlier quarterly growth figures, the main culprit being the hit from inventories for five quarters in a row. Without the resulting drag, Q2 US GDP growth would have been at an above potential rate. Consumption was the bright spot, rising strongly in Q2, but business investment again disappointed. The latest durable goods orders numbers do not yet point to a turnaround. PMIs in the US argue for ongoing growth and we expect a better level in H2, aided by fading headwinds from inventories and the energy sector. The markets for new and existing housing are robust, with a decent upward trend in house prices. Companies appear to be hiring, which in our view should counter fears of a rising recession risk. However, the combination of weak growth and robust job creation might be a sign that trend growth is declining, so monitoring business investment will remain important.


The shock of the Brexit result is fading, with financial markets normalising remarkably quickly. This is a positive as it reduces the risk of contagion via the financial channel. However, uncertainty over the practical implications of Brexit remains high.

After the UK’s relatively strong Q2 GDP growth, the question is whether a flirt with recession will follow. We think the Bank of England’s rate cut on 4 August should have some positive sentiment effects. Overall, though, a sharp drop in economic momentum appears probable. The key will be how soon post-referendum stabilisation can be achieved. The smoother the loss of momentum in the UK, the more likely the country will avoid recession – and the better for the eurozone, too.

Despite the Brexit result, economic sentiment in the eurozone surprised to the upside in July. The bloc’s composite PMIs have weakened slightly, but still point to similar growth in Q3 as in Q2. Depending on how fast UK economic activity slows, headwinds to eurozone growth may arise and a soft patch seems likely, but not more. Lending growth in June was sluggish, but points to a positive stimulus to the real economy from ECB monetary policy action.


The statement from the Fed after the July meeting of the FOMC, published before the latest GDP and labour market data, delivered no big surprises. The Fed sees a decline in short-term risks lowering the hurdle to further rate rise action. Its view of reasonable growth and strengthening labour markets fit well with the data that appeared later. We believe the Fed will continue to move very gradually on its rate-rise path and remain highly data-dependent. That the ECB took a wait-and-see attitude in its July monetary policy meeting was no surprise. The central bank confirmed that it is monitoring the potential impacts from Brexit and awaiting September GDP and inflation projections. However, it left the door open to further action in the autumn.

Financial markets were underwhelmed by the Bank of Japan’s (BoJ) latest easing measures, announced in July. The BoJ said it would reassess monetary policy in its September meeting, so it is likely that it may embark on a more audacious overhaul of its monetary policy later in the year. The BoJ is sticking to its 2% inflation target, emphasising that monetary policy has not reached its limit, while also seeming to be increasingly hesitant to cut deeper into negative rates. Specific parameters for a major fiscal stimulus package were announced. This real additional spending should start to lift growth in Japan from Q4. We await the autumn to see whether the coordinated fiscal and monetary policy actions limit the currency headwind for the Japanese economy.

Finally, the Bank of England (BoE), aiming to offset heightened uncertainty by ensuring confidence in the longer-term outlook, surprised financial markets by cutting its base rate on 4 August to a historic low. It also committed additional new funds to buy bonds and launched a well-funded lending scheme for banks. The BoE indicated that it would tolerate its inflation target being overshot for the next 2-3 years and that it is open to still further action. Another cut in the base rate to close to zero seems quite likely, in our view.


One striking point over recent weeks has been that most asset classes have benefited from market momentum. In our view, this reflects investors’ search for yield and their hopes for additional stimulus by some central banks and the Fed taking a longer pause on its rate increase path. The renewed reliance on monetary policy contrasts with the view earlier this year that QE is becoming increasingly ineffective. The positioning of investors in equities looks somewhat overstretched. We are constructive in our outlook on world growth, albeit that it will likely be at a mediocre pace. The current US earnings season has gone well so far, but it is only looking to beat a low benchmark. In the eurozone, likely dampeners on growth are post-Brexit uncertainty and inflation staying low, which means the environment for corporate profits may remain challenging. In Japan, the disappointment in the BoJ and the stronger yen have made things tougher for company profits. We do not yet see any near-term substantial improvement in the growth outlook for emerging markets, where for many countries debt remains a serious burden and the political situation is fragile.

Over recent weeks, equity markets have consolidated at high levels. Volatility has declined, but markets have not been moving forward strongly. Given this environment, we have increased our underweight in equities via the European leg. Despite inflation staying low, markets seem too complacent about this. We have moved long eurozone inflation by buying linkers and matching the duration exposure by selling nominal bonds. We have kept our underweight in emerging market debt in hard currencies and our underweight in commodities. In government bonds as well as in investment-grade corporate bonds, we prefer the US over Europe.


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