Sustainable recovery….just out of reach

It has been a very interesting period since the end of April as markets undergo a stealthy risk re-rating and equities sell off and bonds rally. Over this period the S&P 500 is down 6.6%, the ASX200 is down 9.5%, US 10 year bonds have rallied from 3.66% to 2.94% this morning. Global growth is slipping away as the easy bounce from the lows and the stimulatory impact of government and central bank action fades. So the outlook is less dangerous now because the financial system is in much better shape but economically we are slipping back toward at least developed world, in not global, economic weakness.

I’ve been writing a lot lately about my circumspection and concern for markets over the northern Summer and these falls are indicative of that concern. But equally I saw a co-sponsored report “Search for Growth” from the Economist Intelligence Unit and BNY-Mellon yesterday which was released on June 1st which highlights that global investors are also feeling uncertain about economies, markets and returns. In many ways we’re all worried that the cloud on the horizon could be the start of a cyclone.

This BNYMellon/EIU collaboration is a treasure trove for researchers such as myself. They have done all the hard work I just have to interpret it. But I thought their introduction spoke volumes for where we are at the moment for markets and investors. They said,

Although a gradual global economic recovery is now underway, these remain uncertain times for both investors and corporations. The economic prospects of key regions are diverging and policy responses are heading in different directions as national governments and central banks seek to tackle their own domestic challenges. And after the near-heart attack of the global financial crisis, investors are continually presented with conflicting information about how to allocate their assets and secure longterm growth.

The search for growth remains challenging and unpredictable. For every indicator that points to a more sustainable recovery, there are others that suggest the emergence of new problems. Although it is not easy to make decisions about how and where to invest in this difficult economic and market environment, it does help to understand how peers from around the world are responding. Our survey of 800 respondents tackles a broad range of themes, including the prospects for growth across sectors, regions and asset classes. At its heart is a set of scenarios; we asked respondents to indicate how likely they thought each scenario was, and then asked them to tell us what impact it might have on their portfolio. The results provide a fascinating insight into the current mindset of investors and executives around the world.

Opportunities and threats seem to be the key take aways. Investors see the former but are, quite naturally concerned about the latter. The Key findings are:

  • Emerging markets offer the best prospects, although there are concerns about overheating.Investors think that emerging markets will continue to offer the best outlook for economic and asset-price growth. Emerging market equities are seen as the asset class with the best prospects, and three of the BRICs (Brazil, India and China) top the list of countries seen as offering the best opportunities for growth. But there are also concerns that investors could be over-relying on emerging markets. Two-thirds think that emerging market assets offer strong growth potential, but are concerned that some markets could be overheating, and almost half agree that investors are pinning too much hope on emerging markets.
  •  Growth is expected to continue but at a slower pace.The consensus among survey respondents is that the global economic recovery will continue. But there is disagreement over the pace of that improvement. Just under one-quarter think that the recovery will pick up momentum over the next 12 months, but almost half say that the pace of recovery will slow over that timeframe. This is likely to reflect concerns about recent shocks, including the political unrest in the Middle East and the earthquake in Japan, as well as fears about rising inflation, particularly in emerging markets.
  •  Commodities offer good growth prospects, but will be a risky asset class.Commodities are seen as second only to emerging-market equities in offering the best opportunities for investment growth over the next 12 months. Industries involving the production of commodities, such as oil and gas; agriculture and agribusiness; and mining and metals, are also the sectors seen as offering the best potential. But again, there are concerns about overheating. Asked which asset class is most likely to be the source of the next price bubble, respondents point to commodities. They also consider that commodities will be the asset class where levels of risk are most likely to increase over the next 12 months.
  •  Concerns abound about the Eurozone, although monetary union should withstand the shock.The majority of investors questioned for this report agree that default of a Eurozone country is looking increasingly likely, although few expect that this will ultimately lead to the break-up of the monetary union. Investors, for the most part, are steering clear of the peripheral markets.
  •  Challenges to global governance are hampering the recovery.A common theme from the survey is a lack of confidence in multilateral decision-making. Only a small minority of investors expect progress on concluding the Doha round of trade negotiations, while there are similarly low expectations for agreement on a global accord to replace the Kyoto Protocol, or a globally agreed solution to the “too-big-to-fail” problem in banking.
  •  Scenario-based approach underscores a pessimistic outlook. In addition to exploring potential sources of growth, the report explores investor views on the likelihood and potential impact of 24 different scenarios. A summary of our findings can be seen in the chart below, which shows respondents’ assessment of the likelihood of a range of scenarios (along the x axis) and the impact on their portfolios (along the y axis). A notable finding is that the vast majority of scenarios that are regarded as likely are also expected to have a negative impact on investors’ portfolios.

These high level take aways speak of continued volatility in trading and markets as the low probability high risk events occupy the minds of investors in the short-term over long run outcomes. This has really important implications for a continuation of short-term style trading and flighty asset prices and moves. Importantly it gives traders the upperhand over investors and means the here and now are just more important than the path we are on and every little piece of data becomes potentially the catalyst for the next big move. This has a feedback loop which then further puts investors ill at ease and thus increases shorttermism.

So we need a sustainable recovery but on all the evidence it doesn’t seem like we are going to get one, just yet. It’s just out of reach.

For our markets here at home I have just posted an Aussie Dollar piece over at macro where I look at the short-term outlook (there we go 🙂 ) and it seems to me it is biased back toward 1.0450/1.05. For the ASX200 our view from Saturday that it is biased toward 4473 remains intact. i’ll post a specific piece on this later today.

greg@lighthousesecurities.com.au

www.twitter.com/gregorymckenna

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