Global growth on solid footing, despite EM headwinds

Jan 6, 2016

For Immediate Release

Hong Kong, January 6, 2016 – Against the backdrop of the possibility of a hard landing in China, emerging market (EM) weakness and currency volatility, collapsing commodity prices, and lackluster demand growth, the key question for 2016 is whether a slowdown in emerging economies would derail the nascent recoveries in developed markets (DM).

“The US will continue to be the major driver for global growth in 2016, with the recent US Federal Reserve’s rate rise an indicator that growth is on a solid footing,” says Dr.John Greenwood, Chief Economist, Invesco. “The good news is neither China nor emerging economies as a group is yet in a position to act as a locomotive for the global economy. Emerging market growth is slowing from 4.6% in 2014 to 4% in 2015, but DM growth is accelerating from 1.8% in 2014 to 2.0% in 2015 and 2.2% in 2016, according to the IMF and other estimates.”

Greenwood sees a hard landing in China as unlikely – he puts 2015 GDP growth at 6.6%, and forecasts CPI growth of 1.6% in 2016 – and if it were to happen, the only economies likely to suffer serious downturns would be its main commodity suppliers such as Chile, and not suppliers of semi-processed, manufactured components (Taiwan, South Korea, Malaysia and Thailand) whose products are ultimately sold into third markets.

“Turning to DMs, Australia and Canada emerge as the most vulnerable to a further slowdown in China, as they are principally suppliers of commodities and raw materials to the country, whereas the US, UK, and Italy emerge as the most resilient as their dependency ratios are small,” he adds.

There is an increasing divergence in EM performance between anufacturing focused economies (China, India, Philippines, South Korea and Taiwan) and commodity exporting countries (Indonesia and Malaysia), he notes.

“Recent EM weakness is a correction of the excessive stimulus measures in those markets following the 2008/9 downturn in developed economies,” Greenwood says, adding that key EMs will continue to recover through 2016 from that episode of overheating, which saw China, India and Indonesia encourage rapid bank credit and broad money growth.

“Broad money growth rates in most EM economies have slowed to the 10-15% range, consistent with slower growth and lower inflation,” Greenwood says.

He expects commodity exporting EMs will likely perform more poorly than manufacturing-focused EMs in 2016, in terms of GDP growth and currency value.

“Unless either the EM group, a big user of commodities, recovers rapidly or there is a surge in demand for commodities among DM economies, which is unlikely, it will be some time before there is a meaningful recovery in commodity prices,” says Greenwood, adding that the currency values of the EM commodity producers have fallen back to roughly where they stood in 2002-3, before the great commodity boom driven by Chinese demand.

Turning to the Eurozone, Greenwood notes the dynamics of broad money and bank loan growth have improved, though they remain weak.

Tepid DM growth remains a reflection of the ongoing process of balance sheet repair, he concludes.

Equity volatility rising

Indeed, Paul Chan, Chief Investment Officer, Asia ex-Japan, Invesco, says low growth, low rates, and low returns will continue through 2016, accompanied by increased equity market volatility.

The US is, again, the bright spot. “Earnings growth in the US supports the outperformance of US equities. Profits have risen since the financial crisis, but the mild recovery, which was driven by domestic profit rebound, is muted by global deflationary pressures,” Chan explains.

“Similar to US firms, share buybacks in Japan have surged, and we expect them to gain momentum. Japanese companies deliver dividends as a vote of confidence. Invesco is positive on future earnings as we see Japanese stocks generating stable returns amid volatility. We like dividend-paying names in a low-rate environment,” says Chan, who notes that total shareholder returns are increasing there.

In terms of factors, across the US, Europe, Japan and Asia Pacific ex-Japan, growth stocks have performed best from January 2013 to November 2015 in US Dollar terms, followed by small and mid-caps.

Notably, in Asia (China, Hong Kong, India, Indonesia, Korea, Malaysia, Philippines, Singapore, Taiwan and Thailand) total exports year-on-year growth in US Dollar terms continues to decline, and has been in negative territory since around mid-2014, a trend mirrored by imports, Chan observes.

In the same markets, credit expansion has either levelled off or is in decline, but non-performing loan rates will likely pick up, he adds.

Turning to China, although a weaker Renminbi is deflationary, a noteworthy development is a rebound in IPOs, with 2015 only superseded by 2010 and 2011 since 2006 in terms of newly floated companies, Chan notes, adding that the IPO pipeline points to similarly buoyant activity in 2016.

Offshore China bonds attractive

Regarding China fixed income, “we see strong value in offshore China bonds, both investment grade and high yield, denominated in either Renminbi or US Dollars, as they provide much higher yields than onshore China bonds of similar maturities and credit ratings,” says Ken Hu, Chief Investment Officer, Fixed Income, Asia Pacific, Invesco. Furthermore, strong demand from Chinese investors, the result of home bias, will make offshore China bonds comparatively more stable than some other Asian, EM or DM fixed income.

China’s economy is at a different stage of the interest-rate cycle than the US and Eurozone and therefore presents diversification benefits.

Furthermore, among major economies, China has more leeway to ease monetary policy, thereby providing further insulation from the Fed’s rate rise. “We see potential in further cuts to the required reserve ratio, of 600 basis points, and the lending rate, of 50 basis points, due to deflationary pressures. This would provide a supportive backdrop for RMB bond prices,” says Hu.

“The Renminbi is a high-yielding currency compared to most major currencies, such as the US Dollar, Euro, British Pound, Australian Dollar and Canadian Dollar,” he says. The Renminbi also appreciated against most of them, except for the US Dollar, in 2015.

Other areas of optimism are long-term US Treasury yields, which Hu sees as having priced in further rate hikes, US and European investment grade corporate bonds, and US bank loans.

As the US has begun to normalize rates, “we see US bank loans as an interesting asset class as their floating coupon rates will rise, thereby increasing interest income for investors,” Hu says.

“On the other hand, we are cautious about commodities and currencies associated with commodity sectors and commodity-exporting countries,” he adds.

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