Strategy & economics
January market review
It is not just on the weather front that we have been faced with the repercussions of inclement conditions in the US. 2013 was a year that various waves of worry with regard to fiscal and monetary policy crossed the oceans to batter confidence in still-fragile economies elsewhere in the world. Despite this, the year ended with the economic climate feeling more temperate, particularly in the UK where it became apparent that activity had gained considerably more momentum than had been widely anticipated.
It was only three months ago that temporary deadlock in the US political system, resulting in a failure to agree and enact legislation for government funding, threatened to cause a prolonged shut-down of government. In the event, an agreement was reached after a couple of weeks, and the crisis passed. This was just one of a series of political clashes between Democrats and Republicans during the year, which started with the intense debate over the implementation of measures designed to contain the budget deficit. The end result was that a fiscal tightening created something of a headwind for the economy during the year, but it was nowhere near as severe as it might have been.
Meanwhile, the guardians of US (and some would say world) monetary policy in the Federal Reserve were wrestling with how to bring to a close the prolonged period of quantitative easing. A new policy concept, that of tapering, entered the dictionary of popular economics terms. Tapering, or gradually slowing the rate at which additional liquidity is added to the system, was widely expected to start in September. In the end, the Fed baulked at the last moment, only to announce after its December meeting that tapering would begin in January 2014. So, as we move into the New Year, we will see the first very tentative steps towards policy normalisation. Even so, it will take most of 2014 before QE is actually concluded, and no one has yet begun to contemplate when or how monetary policy might begin to be tightened.
Throughout 2013, the world economy had to battle through the consequences not just of the machinations in US policy but also of fiscal tightening elsewhere in the developed world, a possible resurgence of the Eurozone debt crisis, a potential hard-landing in China and various international political disturbances. More helpfully, the approach of central banks remained essentially dovish in both deed and word, and during the final months of the year there was more concrete reassurance from upside surprises in economic data in a majority of western economies.
After allowing for the appreciable tightening in fiscal policy and a gradual increase in long-term interest rates during 2013, the performance of the US economy was reasonably impressive. The US has outperformed all other major industrialised economies since the peak of the previous cycle and is likely to remain the driver of global growth in 2014. With less of a fiscal headwind (equivalent to approximately -0.5% of GDP in 2014, down from -1.5% in 2013), we believe the economy should grow by 2.5%. Within this, we would hope to see an improving contribution from small and medium-sized enterprises (SMEs). This would help provide the economy with greater resilience, most importantly through the positive impact it would have on the labour market. More generally, the US economy would benefit from the rising employment becoming associated with slightly stronger wage growth. Helped by stronger activity, the budget deficit should shrink further as tax receipts pick up, while the trade deficit should reflect the positive impact on imports from rising domestic energy output.
There are encouraging signs that Europe is now in a phase of recovery and realignment. In the UK, the economy grew appreciably faster in 2013 than was widely anticipated at the start of the year. Improved momentum was particularly evident in the second half of the year. Within the consumer economy, there is no doubt that activity has been boosted by the help provided by the government to the housing market. More worryingly, while corporate confidence has recovered, capital investment levels have been disappointing and productivity growth has been disappointing as a result. While we expect growth to be faster in 2014 than in 2013, we believe there is a risk that expectations run ahead of reality. Sure, the UK economy is on the mend (and has probably grown more over the past couple of years than official statistics indicate). But, for the economy to develop more resilience, we must see productivity-based increases in real wages, and these can only come through once we have seen an upswing in the investment cycle.
In the Eurozone, the Purchasing Managers’ Index (PMI) for manufacturing ended 2013 at a 31-month high, with Germany posting a robust reading while Spain and Italy improved further on rising new orders. Despite this, the situation within the euro area remains very mixed, and although we expect growth trends to improve in 2014, there will still be very evident stresses. Most positively, perhaps, growth in southern Europe appears to have resumed, albeit from a very low base. Germany should also post better numbers in the year ahead than in 2013, although its reliance on exports to Asia has hampered its recovery. At the weaker end of the scale, France remains hamstrung by confused macro policies and structural inflexibility. Generally, 2014 should see less drag from austerity, and some help from easier credit conditions and improving world trade. As in the UK, however, we need to see stronger corporate capital spending during the next phase of the cycle. Without this, the trends productivity and wages will remain weak. It is interesting that the ECB has focused more attention on falling price inflation over recent months – something that has persuaded it to continue to ease monetary policy. In our view, the greater deflationary threat comes not from lower consumer price inflation but from negative real wage growth.
Japan regained investors’ attention in 2013 thanks to its bold economic revitalization plan, namely ‘Abenomics’, which encompasses fiscal, monetary and structural reform. The most obvious consequence of the Bank of Japan’s unprecedented monetary easing has been the 17.7% slide in the yen. There is some evidence that greater competitiveness has boosted exports and that rising inflation expectations have helped trigger stronger growth in household spending – both of which have helped raise GDP growth. Other indicators, such as the Manufacturing PMI, corporate confidence and labour market conditions, are also looking more positive, encouraging the view that Japan is now emerging from more than 15 years of deflation.
The constructive case for 2014 is based on the joint arguments that rising wage inflation will support stronger household spending and that improved corporate confidence and profitability will kick start the investment cycle. The risk to this assessment is that the drag from an impending hike in the consumption tax, which will take effect in April 2014, will delay the recovery in consumption and that renewed uncertainty will cause companies to hold back on capital investment. Reassuringly, the Japanese government has rolled out an offsetting package of fiscal measures and the BOJ is likely to ease if the negative impact of the hike in sales tax becomes too great. Against this backdrop, it is unlikely to be until later in 2014 that we can reach a firm conclusion on medium-term prospects.
In China, activity stabilised toward the end of the third quarter after the government introduced mini-fiscal stimulus and injected liquidity into the interbank market. Having said that, more recent indicators have been disappointing, raising concerns that the economy is set for a hard landing. Although it is clear that China aims to rebalance growth toward consumption, it is likely that investment will continue to drive growth in 2014. In policy terms, the People’s Bank of China is likely to remain relatively flexible and as the reserve requirement ratio is at 20%, there is ample room for easing if activity continues to decelerate. After the Third Plenum, the government rolled out a comprehensive reform package covering financial, economic and social aspects.
As what are intended to be reforms come through, there should be clear longer-term winners (private companies focused on the home market) and losers (state-owned enterprises). Before this, the focus for 2014 will be the extent to which there has been a real loss of economic momentum.
This article is issued by Cazenove Capital Management which is a trading name of Schroder & Co. Limited, 12 Moorgate, London, EC2R 6DA. Authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. Issued in the Channel Islands by Cazenove Capital Management which is a trading name of Schroders (C.I.) Limited, licensed and regulated by the Guernsey Financial Services Commission for banking and investment business; and regulated by the Jersey Financial Services Commission.
Nothing in this document should be deemed to constitute the provision of financial, investment or other professional advice in any way. Past performance is not a guide to future performance. The value of an investment and the income from it may go down as well as up and investors may not get back the amount originally invested.
This document may include forward-looking statements that are based upon our current opinions, expectations and projections. We undertake no obligation to update or revise any forward-looking statements. Actual results could differ materially from those anticipated in the forward-looking statements.
All data contained within this document is sourced from Cazenove Capital Management unless otherwise stated