2016 Q1 House Views Update
by Nikko Asset Management's Global Investment Committee

Introduction

Nikko Asset Management's Global Investment Committee met on March 29th and updated our intermediate-term house view on the global economic backdrop, central bank policies, financial markets and investment strategy advice.

We expect June and December Fed hikes, but only mild further easing ahead for the BOJ and ECB. Meanwhile, we expect oil prices to creep higher through 2016 despite the stronger USD due to relatively firm economic developments in China and the G-3.

We expect that global equity and bond investing will be positive for Yen based investors due to Yen weakness, but for USD based investors, we are taking only a neutral stance on global equities due to a cautious forecast for US equities, whereas we are positive on Asia-Pac ex Japan, Japan and Europe. Meanwhile, we are moderately negative on bonds in each region when measured in USD terms, so we underweight them.

G-3 and Chinese Economies Moderately Firmer in 2016

In our view, the G-3 economies will fare moderately well in the next four quarters, although the 1Q will likely be quite slow, especially in the US and, depending on the inventory factor, in Japan too.

The US economy continues to experience mixed conditions, but consumer spending in real terms remains firm. 1Q GDP growth may only be around 1.0% QoQ SAAR, but we believe that it will match the 2.3% HoH SAAR consensus in both the 2Q16-3Q16 and 4Q16-1Q17 periods. Capex and net exports will likely be soft in the 2Q, but will likely rebound thereafter as the effects of the weak oil price fade. Meanwhile, inventories should stop subtracting much from growth after the 1Q, 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 forecast that payroll growth will decelerate slightly on a YoY basis, but that the unemployment rate will continue to decline a bit further. As for wages, we still believe that the official monthly data is likely understating growth due to generous wage settlements in many industries. In sum, the labor markets remain in very good shape, but are not overly tight.

Retail unit auto sales have remained fairly high in recent months, although down from peak levels and it is noteworthy that luxury auto sales have been quite weak this year. Overall retail sales for goods will likely show positive MoM readings in nominal terms again and excluding gasoline, sales are likely to remain very strong, as well as on a “real” (inflation adjusted) basis.

As for other data:

  1. regional ISMs have been very strong;
  2. new home sales remain in a firm upward trend;
  3. durable goods orders remain sluggish, especially for the energy and agriculture sectors, but with slightly rising oil prices and better global growth, they should start to rise from recently low levels. Meanwhile, US housing prices are strong, which creates a large wealth effect for consumers.

Japan’s 4Q GDP was even weaker than we expected due to subdued real consumer spending, as wages have not increased as much as was hoped, but real wages should improve 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. In sum, we forecast GDP at 1.3% HoH SAAR for the 2Q16-3Q16 period, followed by 1.6% in the subsequent two quarters. As for inflation, the CPI ex food and energy should remain around 0.9% YoY in the coming quarters 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 be delayed (although this is a very close call) 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 continue to be fairly good, but as we predicted, a bit softer than consensus. The fate of the economy, especially via tourism, is shaded by the recent Brussels attack and fears of similar ones. We forecast GDP growth at 1.7% HoH SAAR in both the 2Q16-3Q16 and 4Q16-1Q17 periods, which might be slightly above consensus now. Firstly, there has been a strange surge in industrial production in the region, which if unrevised, portends well for GDP growth. PMIs have also improved significantly. Exports will likely remain soft for the next few months, but will likely start improving due to better demand from China’s stimulus program and some rebound in emerging market demand. Capex, tourism spending and government spending should remain soft, however. Meanwhile, low oil prices will keep inflation flat YoY for the next few months, but core inflation, which never went negative, should continue near 1% YoY before rising later. Meanwhile, European property prices continue to rise (a longstanding theme in our thought leadership effort), which adds to the wealth effect and to increased housing capex.

Greece and the rest of the periphery remain tail risks for Europe, but we still expect such will be contained. We continue to believe that the largest 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. Related to this is the Brexit vote. We do not believe that it will approve an exit, but it will likely be a very close vote.

China continues to struggle during its transition to a more balanced economy, but does not appear to be in an overall hard landing. Certainly, volatility in its equity and currency markets has lessened confidence in the country’s stability, but we expect it to achieve 6.4% HoH SAAR growth both in the 2Q16-3Q16 and 4Q16-1Q17 periods, 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. Meanwhile, top tier cities’ property prices are surging even further, and middle to lower tier cities’ prices have rebounded somewhat, which should lead to improved housing starts this year. Importantly, auto sales remain strong and are a major stimulus to the economy.

Although its reform efforts have been disappointing so far, the government is acting rapidly to counter economic deceleration. Besides trying to stabilize the stock market, it has increased infrastructure spending and loosened rules for local government financing. Importantly, it is starting to let state-owned enterprises in certain industries (especially polluting ones with overcapacity) go bankrupt or enter forced restructurings. This may cause some upheavals, but such is necessary. For this reason, industrial production will continue to be constrained, but the service sector will likely remain very firm.

Other Emerging economies have remained reasonably stable in the past quarter, although Brazil is still struggling with its economy and political stability. Mildly rising commodity prices, however, will likely provide a boost, and investor sentiment has already anticipated improvement (and erased the disaster scenario). External debt in USD terms, both bonds and bank debt, of EM corporates remains 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.