April produced numerous signs of global economic moderation with declines in various leading indicators, not to mention commodities prices. However, with the absence of any major negative shocks to the system and continued accommodative posturing by Central Banks, the most likely outcome appears to be a resumption of global economic recovery in the coming months.
The beginning of 2013 was marked by a significant shift in sentiment. With the fiscal cliff behind and relative stability in the Euro Zone, market participants began to raise their economic expectations. The JP Morgan Global Manufacturing Purchasing Managers’ Index (PMI), a leading indicator of business sentiment, rose to an 18-month high in January. Meanwhile, the Citigroup Economic Surprise Index (ESI) for the G10, a key indicator for market perception of potential economic surprises in the world’s major economies, remained near peak levels which suggests all positive surprises have been incorporated in forecast adjustments. The International Monetary Fund (IMF) also revealed its economic forecasts for the year, with global GDP growth at 3.5%, up from 3.2% in 2012, led by emerging economies at 5.3% while US growth stabilizes at around 2.1%.
However, data released in April suggests that recovery in 2013 might not be as easy as initially thought. The JP Morgan Global PMI declined only moderately in April, but there were sharp dips in the Chicago PMI, as well as key subcategories of the China PMI, which raised red flags among market participants. Meanwhile, the Citigroup G10 ESI retraced to its lowest levels since August. We also saw some renewed fears related to the potential end of stimulus in the US, structurally lower growth in China and the ongoing recession in the Euro Zone. As a result, the IMF reduced its 2013 global GDP growth forecast to 3.3% in its April update with economists at various banks following suit, in some cases to below 3.0%. Commodities prices also began to collapse on expected lower demand, especially from China.
Despite these clear signs of moderation in the global economic outlook, it appears to be transitory and unlikely to produce the bouts of doom and gloom that we have seen in recent pullbacks. This is primarily due to:
· The absence of major shocks. With Cyprus ring-fenced and North Korea having gone quiet, it seems that major shocks are unlikely.
· Euro Zone relative stability. Government deficits have been slashed, trade deficits have been eliminated and breakup risks have been marginalized.
· Japan stimulus. Better late than never, but coming at a time when Japan’s economy was already recovering, suggesting rapid recovery during 2013.
· US growth beyond fiscal constraints. The IMF still has growth at 1.9% in 2013, which is net of a 1.8% fiscal drag. Housing and manufacturing recovery continues.
· China flexibility. Although bent on rebalancing growth and reluctant to inject stimulus, China still has plenty of firepower if needed.
· Emerging markets, business as usual. Many growing above the global average with low debt levels, ample reserves and room to add stimulus.
The other leading indicator that recovery should resume has been equity markets, which have shrugged off recent data. Despite a sharp retracement in mid-April, the MSCI World Index and S&P 500 Index have both recovered since then to post even higher year-to-date returns of 10% and 12%, respectively, as of April 30. It is clear that investors are more focused on stimulus, and thus even greater liquidity than markets are experiencing today. Returns have also been helped by improving corporate profits on both growth recovery and efficiency efforts amidst capital restraint.
Market sensitivity to high frequency data has undoubtedly increased since the 2008 global financial crisis, but the world appears to be in better shape today with global economies on track to achieving what the IMF described in its April update as a “three-speed recovery”. This is led by strong growth in emerging economies, as well as a pick-up in US growth, while the Euro Zone muddles through.
Brian P. Chase is Portfolio Manager, Head of Andean Equities, at Itau Asset Management.