Political decisions – the fear factor for global markets, Russell Investments Sturkenboom comments

Wouter Sturkenboom, European Strategist at Russell Investments reflects on 2013 and provides a global outlook for 2014.


The defining feature of the post-Lehman world is de-leveraging and sluggish growth that has left the major economies with plenty of spare capacity and minimal inflation pressure. We are expecting synchronised growth next year and a strengthening low-inflation recovery across the major economies should favour equities over bonds despite relatively full equity market valuations.

The US economy has few imbalances and is in the middle of a fairly sturdy expansion. The current political stand-off will deliver more fiscal cutbacks that will halt the momentum of the economy. Without this, the US could achieve nearly 3% growth next year and job gains of 200,000 per month.

It’s a similar story in Europe where long-anticipated signs of economic recovery could soon be challenged by the failure to create a proper banking union. European equities are favourable on valuation grounds, but failure to deal with the banking issues could derail this.

Even in Japan, policy mistakes are the main risk. Abe-nomics is a success and has turned Japan’s economy around. However, Shinzo Abe’s introduction of a hefty consumption tax increase while the recovery is gathering momentum is risky.

European and Japanese equities are attractive, especially in comparison to the US, and emerging markets are once again presenting opportunities as equities have been trading at a 25% discount to developed markets.

US: Debt-ceiling deadline holds global economy to ransom

• Fed policy will be a decisive factor for markets
• Economic growth in the US at the end of 2013 will have been below 2% for two out of the last three years, as this year is likely to finish with 1.6% growth on a year-on-year basis
• Fiscal-policy tightening, actual and prospective, contributed significantly to these sub-par outcomes
• There are likely to be lengthy pauses and gradualism on the path of interest rate normalisation, even as monthly jobs gains cross 200,000 per month

If fiscal tightening continues in 2014 at the same pace, it is unlikely that equity markets will find a silver lining, as they did in 2011 and so far in 2013. Each debt-ceiling deadline involves holding the global economy and capital markets to ransom. The bond markets have overreacted to the non-taper decision and the U.S. government shutdown, but overall impact of QE has been smaller than the headlines would suggest.

The eurozone: positives continue to outweigh the negatives… just

• Eurozone left recession in Q3 and economic growth should remain positive, but lacklustre, in 2014 at between 0.5% and 1.0%
• Growth is insufficient to lower debt burdens and/or unemployment rates, and structural reforms are largely non-existent
• Periphery is still stuck in its debt trap but biggest threats are French weakness and negative credit growth
• ECB may be slow, but it is dovish and gearing up to provide more support soon
• Markets face volatility as we approach political hurdles with the renegotiation of the Greek and Portuguese bailouts, as well as a major institutional dilemma with regard to the implementation of a European banking union

Whilst we have seen political fireworks in the US, the policy and political risks that have kept us modestly concerned in Europe have been mitigated. The positives continue to outweigh the negatives-albeit barely. Growth may be lacklustre, but the recession is over and austerity is in decline. Valuations may have gone up, but euro-zone equities look outright cheap relative to US equities.

Asia: Abenomics rejuvenated Japanese economy but stability of bond market under threat

• Japanese economy is undergoing meaningful growth resurgence; equities are attractive but bonds offer poor value and are at risk in the medium-term
• Shinzo Abe’s leadership, which has included a significant devaluation of the yen, fiscal and monetary stimulus and structural reform, has resulted in rejuvenation of the economy
• Japan’s real GDP growth has been sustained in the order of 4% and money growth, which was languishing close to zero at the beginning of 2013, is now printing a healthy 3% year-on-year (as of September 30, 2013).
• There are strong prospects for Emerging Asian equity markets over next 12 months
• Value to be found in Australian and in New Zealand long government bonds as currencies of both markets remain expensive.
• In Japan, accelerating growth and accelerating inflation may combine to destabilise the bond market and shift interest rates higher on a 12-month view.

Challenges still remain for Japan, although they are not insurmountable. Most notably, it will be hard to maintain current levels of fiscal discretionary stimulus to support consumer spending. Japan’s welfare budget is constrained by the persistent demands of a markedly aging population, in conjunction with a debt/GDP ratio already approaching 250%. It will be important for wage inflation to join CPI inflation on an upward trajectory, if a sustained lift in private consumption spending is to be achieved.

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