2015 Q1 House Views Update
by Nikko Asset Management's Global Investment Committee

Nikko Asset Management's Global Investment Committee met on March 24th 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 prevent moderate increases 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 tapering process, which readers will likely recall many strategists proclaiming would cause a crisis. Indeed, global equities have risen sharply from pre-“taper- tantrum” levels despite all the prior fears. However, we now only look for moderate equity gains in the year ahead, with valuations remaining relatively steady.

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 exceed the current consensus for economic growth going forward, but primarily because 1Q growth is slow due to unusual factors that will reverse in the quarters ahead, much like what occurred in 2014. In particular, the US should rebound from the unusually brutal winter and the West Coast port strike. The Eurozone and Japan should recover faster than expected too. China's economy, however, should match (using the dubious official statistics) consensus, although there certainly are several large and well-renowned tail risks there.

The US economy certainly has mixed conditions, but consumer spending is the most important factor, and we believe that will continue very firm. GDP should grow 3.2% HoH SAAR in the 2Q15-3Q15 (and the following two quarters, as well), with consumer spending and housing construction leading the way. Capex and net exports should be soft, however. 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 will continue to decline. As for wages, we still believe that the official monthly data, despite some recent acceleration, is likely understating growth, with 3-month SAAR at near post-Lehman shock lows. With numerous strikes and most major retails hiking wages quite sharply, this should easily offset any weakness in energy industry-related wages.

A key determinant of growth in the US will be auto sales, which slowed in February due to the weather. Investors should watch future sales closely. Retail spending is soft on a nominal basis due to low gasoline prices, but are strong on a “real” (inflation adjusted) basis. Although February was soft due to the weather, on a three month average rate, ex gasoline retail sales are strong, as are real overall sales. New home sales are rebounding, but durable goods orders have weakened in recent months. In particular, aircraft orders have weakened as customers are likely cancelling prior orders as the fuel efficiency does not need to be improved and many countries and customers, especially in MENA and emerging markets are cutting expansions. Orders for the energy industry are weak, as well, and will likely continue to be so.

Japan's economy rebounded in the 4Q, although not by much as inventories fell sharply. We still believe that growth is understated by low inventories and other unusual factors, so it unclear what 1Q GDP growth will be, but in sum, we forecast 2.8% HoH SAAR growth in the 2Q15-3Q15 and 1.9% HoH SAAR growth in the following two quarters, moderately above consensus. One area of particular strength are “real” exports, which have finally begun to accelerate sharply. Personal spending should also accelerate as “real” wage growth is very high now, especially due to recent wage negotiations. The wealth effect and increased confidence should also support spending (and perhaps housing construction, as well). As for inflation, the CPI should be below 0.5% YoY for the next two quarters, as while the weaker Yen helps matters, declining gasoline prices should prevent the BOJ from attaining its 2% core CPI goal this year.

In the Eurozone, conditions are improving quite broadly (better than we or consensus expected), and should improve even further going forward. We forecast GDP growth at 2.1% HoH SAAR in the 2Q15-3Q15 and 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). Lower oil prices kept inflation much lower than we expected, but this is positive for economic growth and allowed the ECB to finally implement sovereign QE. We do keep in mind, however, that underneath the surface, the entire system remains quite fragile. We believe that Greece will avoid leaving the Eurozone, although it is clearly a large tail risk and may require a change in government or key figures. Clearly, geopolitical conditions are also key, but we continue to believe that the Ukraine situation will remain essentially a stalemate, with neither side wishing to push much further.