2015 Q4 House Views Update
by Nikko Asset Management's Global Investment Committee

Introduction

Nikko Asset Management's Global Investment Committee met on December 8th and updated our intermediate-term house view on the global economic backdrop, central bank policies, financial markets and investment strategy advice.

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 US economy will fare moderately better than consensus in 2016, but Japan and Europe's economies will mildly disappoint consensus due to their lower economic dynamism.

The US economy certainly continues to experience mixed conditions, but consumer spending in real terms remains quite firm, although not as strong as many had hoped. GDP in the 4Q may only be around 1.2% QoQ SAAR, but we believe that it will slightly exceed the 2.4% HoH SAAR consensus in both the 1H16 and 2H16. Capex and net exports will likely be soft, but inventories should stop subtracting from growth in the coming year, personal consumption and housing investment should remain sturdy and government spending should rise along with increased tax revenues derived from higher housing prices.

As for employment, we continue to believe that payroll growth will decelerate but that the unemployment rate will continue to decline a bit further. As for wages, we still believe that the official monthly data, despite some recent acceleration, is likely understating growth. With numerous strikes and most major retailers hiking wages quite sharply, this should more than offset any weakness in energy industry- related wages.

Retail unit auto sales surged to even higher levels in recent months, averaging over 10% YoY growth, and heavier and more expensive vehicles are preferred because gasoline prices are so low. Spending on other goods and services are also quite firm. Overall, retail sales on goods will likely show negative MoM readings in nominal terms for several months due to declining gasoline prices, which may scare those seeking hints of deflation, but excluding gasoline, sales are likely to remain firm, as well as on a “real” (inflation adjusted) basis.

As for other data: 1) the non manufacturing ISM is off its highs but remains strong, which is key because services are the largest part of the economy; 2) new home sales have leveled off in recent months, but should rebound in the coming months as affordability remains good and existing home prices and rents continue to rise; 3) durable goods orders remain sluggish, especially for the energy and agriculture sectors, and will likely remain so.

The first result of Japan's 3Q GDP was even weaker than we expected due to plunging inventories, but during our meeting process, it was revised upward to show a 1.0% QoQ SAAR gain. Our estimates for economic growth in 2016 are based upon the original 3Q estimate, and we expected lower than consensus growth of 0.8% in the 1H16 and 2H16.. The primary problems have been subdued real consumer spending, as wages have not increased as much as was hoped, but real wages should improve a bit in 2016 and the wealth effect and increased confidence should support spending (and perhaps housing construction, as well). Capex and government spending should grow slightly, but there is uncertainty about the level of the contribution from external trade. As for inflation, the CPI ex food and energy should remain around 0.9% YoY in the 1H and as always, it is key to watch if the CPI housing rent component starts rising. Other key issues to watch are whether the government decides to delay the upcoming April 2017 VAT hike of 2% and the results of a July 2016 national election. We forecast that the VAT hike will occur as planned and that the odds of a LDP 2/3rds majority in the Upper House are very slim, but that it will still be a large victory for the LDP.

In the Eurozone, economic conditions improved, as we predicted, but the fate of the economy, especially via tourism, is shaded by the recent Paris attack and fears of similar ones. Thus, we forecast GDP growth at 1.3% HoH SAAR for the 1H and 2H of 2016, which is moderately below consensus. The weakness of the EUR should continue to help, but exports will likely remain soft due to low demand from China and emerging markets. Capex, tourism spending and government spending should also remain soft. Lower oil prices will keep inflation slightly negative for the next few months, but core inflation, which never went negative, should continue near 1% YoY. Meanwhile, European property prices continue to rise (which is a longstanding theme in our thought leadership effort), which adds to the wealth effect and to increased housing capex. We do not expect another major terrorist attack in the coming quarter, but worries about such will remain. As for other geopolitical conditions, we continue to believe that the Ukraine situation will remain essentially a stalemate, with neither side wishing to push much further.

Greece remains a tail risk, but we still think it will avoid catastrophe and implement, at least in the short term, its program. Voters in Portugal were not so chastened by Greece's tumult, and voted heavily for the left-wing recently, but at least the country has a highly competent bureaucracy and is dedicated to remaining with the Euro. Perhaps the larger threat to European unity now comes from the right wing, as seen in France, due to anti-immigrant and anti-integration sentiment among voters, but it is often too easy to over-estimate this factor.

China continues to struggle during its transition to a more balanced economy, but does not appear to be in an overall hard landing. Certainly, the recent volatility in its equity market and the Yuan has lessened confidence in the country's stability, but we expect it to achieve 6.3% HoH SAAR growth in the next two halves, which matches consensus. Inflation remains very low, as measured by the CPI, and pipeline inflation remains negative. Exports are subdued, while imports in value terms are suppressed mostly by lower commodity prices. Housing starts were weak in 2015, but housing sales have risen sharply. Indeed, top tier cities' property prices are very strong, and middle to lower tier cities' prices have rebounded somewhat, which should lead to improved housing starts next year. Importantly, auto sales have surged as the government introduced new subsidies, a fact that is proving to be a major stimulus to the economy.

The government is acting rapidly to counter the deceleration in other parts of the economy, as well. Besides trying to stabilize the stock market, it has increased infrastructure spending and loosened rules for the property market and local government financing. It continues to encourage the expansion of the new municipal bond market, in which banks are encouraged to buy bonds at low interest rates instead of lending to local governments.

Lastly, industrial production will continue to be constrained so as to reduce pollution and we continue to expect (as we have for several years) that huge efforts will be made, even beyond current optimistic projections, on solving this problem, which will provide many good investment opportunities for global providers of pollution control equipment of all kinds.

Other Emerging economies have remained reasonably stable in the past quarter, although Brazil is still struggling with its economy and political stability. A strong USD and softness in commodity prices, however, will likely be major headwinds and political troubles are multiplying. External debt in USD terms, both bonds and bank debt, of EM corporates is a critical factor to watch, especially as the latter can be redrawn relatively quickly. Rating agency downgrades of the corporations, often linked to declines in the sovereign rating, are occurring much more rapidly these days and some of these corporates are very large debtors, especially in Brazil.