No Double-dip, but Slowing Growth; Emerging Markets Should Outperform
World economic recovery continues but the dynamism of the upswing is waning. However, gloomy reactions to US economic data during the summer appear overdone: We expect positive growth in the US and a soft landing in China. Emerging market stocks should outperform their peers from industrialised economies. The growth differential remains substantial. Bond markets are due for a correction: Record- low yields on high-quality debt are pricing in another relapse into recession. We do not share that opinion and remain bearish on government bonds. Investors should remain positioned for a global recovery.
The economic recovery continues. For the current year, the major economies are likely to record positive growth rates ranging from 1.5 – 3 per cent; but growth rates will be more moderate in the second half of the year.
The latest signs of a slowdown in US economic growth have come surprisingly early. Despite a change of trend in the labour market, the private sector is still not creating enough new jobs to boost consumer spending and push up tax revenue. But it is likely that special factors are concealing a more solid underlying picture. Corporate investment, in particular, supports our more optimistic scenario. We do not share the opinions of a renewed slide into recession.
The debt crisis will put a break on the European recovery soon. Europe’s recovery is proceeding only sluggishly over- all. After a weak first quarter, GDP grew by 1 per cent in the following three months. The only convincing performer at first sight is Germany. German exports are expanding vigor-
ously. But Germany cannot sustain the Eurozone’s recovery alone. We expect export growth in Germany and even Swit- zerland to decelerate, but Switzerland has a good chance of remaining an oasis of stability amid the current turbulence in Europe.
Go Overweight on Emerging Market Stocks; Stay Bear- ish on Government Bonds
The growth differential between emerging markets and the main industrialised economies remains in favour of the emerging markets, especially after the slowdown in US growth. We recommend a rebalancing towards firms with a large exposure to Asian domestic demand. Export-based growth will be subdued with global growth slowing.
Yields on US Treasuries and German Bunds continue on what appears to be a relentless downward spiral. A signifi- cant drop in inflation expectations over the past several weeks contributed greatly to the decline in yields. In addition the Fed is once again moving to prevent another slide into deflation and is reinvesting the proceeds from repaid mortgage-backed securities through the purchase of US government bonds.
The current yield levels suggest that bond investors are expecting a relapse into recession accompanied by defla- tionary tendencies. We do not share that opinion. Rather, we view the G7 bond markets as expensive and are anticipating a correction. Bond investors should take this possibility into account in their investment decisions. We recommend that investors hold an underweight in Government Bonds and keep their maturities relatively short. Furthermore we still recommend bond holders to diversify into corporate debt.
