Nikko AM’s Global Investment Committee met on September 26th and updated our house view on the global economic backdrop, financial markets and investment strategy advice. In sum, there certainly are some worrisome issues, as always, but we find none of them convincing enough to halt the upward momentum in equity prices. Even rising US interest rates are consensus now, so although there may be volatility as such crystallizes, it may be no more problematic than the nearly completed tapering process, which readers will likely recall many strategists proclaiming would cause a crisis. Indeed, global equities have risen 20% in USD terms from pre-“taper- tantrum” levels, but we only look for half of that rate in the year ahead, with valuations remaining relatively steady. The story is much the same with global bond and forex markets, which have already nearly fully priced in mid-2015 Fed hikes.
The Global Economic Backdrop
(note that all dates in this report are Calendar Year (CY)- based and growth numbers are seasonally adjusted annual rates (SAAR) unless otherwise specified)
In our view, the G-3 will closely match the current consensus for economic growth going forward, with the US remaining very firm and the Eurozone and Japan recovering steadily in the 4Q14 and 1Q15, although there certainly are many doubters in the market on the latter two regions. China’s economy, however, will likely be weaker (using the official statistics) than consensus. Our concern about China continues to be its property market and credit system, which the government is determined to reform, even if it entails pain, and which is experiencing a surge in non-performing debts. As shown on p.1, there are signs that China’s import demand is declining, not just for commodities, but also for finished goods, which may indicate weakening personal consumption and factory expenditure, partly due to the wealth effect of lower property prices, but clearly still related to the anti-corruption crackdown, as well. However, we still do not expect a hard landing in China.
The US economy is very firm and we agree that it will continue at the consensus rate of 2.9%-3.1% HoH SAAR for the 4Q14-1Q15 (and the following two quarters, as well), with consumer spending, capital expenditure and housing construction leading the way. As for employment, we continue to believe that payrolls will expand at a healthy rate, especially in the housing construction and related services areas, and that the unemployment rate may overstate the problem as the growth of employed persons in the household survey continue to greatly lag growth in payrolls. We forecast December’s unemployment rate at 5.9% with further small declines through March, which will confirm the Fed’s policy of removing monetary accommodation at a moderate rate.
As for wages, we still believe that the official monthly data, despite some recent acceleration, is likely understating growth, because it assumes non-hourly wage earner’s average growth is only about 1.8% YoY, whereas we believe it is likely to be higher than that. Meanwhile, non-supervisory wages have accelerated to 2.5% YoY, which is now quite a bit faster than the 1.7% CPI YoY rate, a fact that should certainly catch the Fed’s eye. While not at panic levels, this data clearly does not warrant emergency-level policy for much longer.
Perhaps the strongest sign of growth in the US is in auto sales, which continue to surge above pre GFC- levels. Retail spending is solid, new home sales are rebounding and ex-aircraft durable goods orders have accelerated further in recent months (and are surging if you include aircraft).
Japan’s economy fell much more sharply in the 2Q14 than we, or consensus, expected in June. We still believe that growth is understated by low inventories and other unusual factors. For more details, see.p. 6-7, but in sum, we forecast a 2.8% to 2.9% HoH SAAR growth rate in the 4Q14-1Q15 and a 1.7%-1.9% HoH SAAR rate in the following two quarters, slightly above consensus. One area of particular strength is orders for machinery, both from the foreign and domestic sectors, which should support economic growth in the coming quarters. As for inflation, the CPI is losing momentum, as while the weaker Yen will help matters, declining oil and utility prices may prevent the BOJ from attaining its 2% core CPI goal even by next spring. Further helping the economy, we expect global coordination efforts to reduce Europe’s dependence on natural gas will highly motivate Japan to reduce its gas imports by starting a few reactors in the 4Q14 and even more in the 1H15. It is hard to overestimate how much this would improve business sentiment in Japan and energy costs for the entire economy would be helpfully reduced.
In the Eurozone, conditions were weaker in the 2Q than we or consensus expected, substantially due to the effects of the Ukrainian crisis, but should improve going forward. We forecast GDP at 1.2% to 1.4% HoH SAAR in the 4Q14-1Q15 and 1.6%-1.8% in the following two quarters. The weakness of the EUR and some improvement in credit conditions should help significantly (we are even seeing upward momentum in Spanish property prices, not to mention northern European ones), with the former likely pushing the CPI rate up near 1%YoY by December, and thus reducing fears of deflation. We do keep in mind, however, that underneath the surface, the entire system remains quite fragile. Clearly, geopolitical conditions are key, but we continue to believe that the Ukraine situation will remain essentially a stalemate, with neither side wishing to push much further.