2015 Q3 House Views Update
by Nikko Asset Management's Global Investment Committee
- Our logic for the Fed hiking in October and thereafter
- Forecasting a Stronger USD and Higher Bond Yields
- Why Neutral Global Equities, with US Underweight, but Japan and Europe Overweight?
Nikko Asset Management’s Global Investment Committee met on September 17th and updated our house view on the global economic backdrop, financial markets and investment strategy advice. This meeting was more challenging than most, but the truth is that all of them are very challenging, as humorously referenced by the quote of a famous baseball coach, Yoji Berra: “It’s difficult to make predictions, especially about the future.” This meeting also came after we, along with most of the rest of the world, were caught off-guard by the upheavals in the Chinese markets, which stymied our mid-June meeting’s prediction of several Fed rate hikes and continuing upward trends in global risk markets. On the bright side, our expectations back in June for G-3 GDP growth for the 2H15 are nearly exactly on target with consensus now.
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 economies will fare reasonably well, and basically match the current consensus in the next few quarters; however, there will be significant challenges for each region.
The US economy certainly continues to experience mixed conditions, but consumer spending in real terms is quite firm, although not as strong as many had hoped. We believe that such will continue firm, but for the US to match the 2.6% QoQ SAAR consensus for the 4Q15-1Q16 period, final demand will need to be quite high, as inventories surged in the 1H and will likely subtract from growth in the coming quarters. Indeed, for this reason, along with sluggish capex and net exports, 3Q GDP may well negatively surprise the consensus. If there is a positive surprise factor, it will likely be local government spending, which will rise along with increased tax revenues derived from higher housing prices.
As for employment, we continue to believe that payrolls will expand at a healthy rate and 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.
We continue to watch US auto sales very closely as the key factor for US personal consumption growth. They are at high levels now and might not grow much further, so spending on other goods and services hold the key to the US economy. Overall, retail sales on goods will likely show negative MoM reading 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. New home sales continue to rebound and permits for new home construction are very strong, but durable goods orders remain sluggish, especially for the aircraft, energy and agriculture sectors, and will likely remain so.
Japan’s economy was even weaker than expected in the 2Q, even though inventories increased. The primary problems are subdued real consumer spending, as wages have not increased as much as was hoped, and net exports. Although many street economists expect inventories to subtract greatly from GDP growth, this pessimism seems unwarranted to us because of the massive decline in inventories since 2009 (whereas the US has built inventories massively). We, thus, forecast 1.5% HoH SAAR growth in the 4Q15-1Q16 period, basically close to consensus. Personal spending should firm up a bit as “real” wage growth should rebound in September onward (especially as inflation will likely be very low due to declining gasoline prices). Once the current wrangling over defense policy is over, the wealth effect and increased confidence should also 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 should be 0.2% YoY in the 1Q16, as while the weaker Yen helps matters, declining gasoline prices should prevent the BOJ from attaining its 2% core CPI goal. CPI ex food and energy should remain around 0.6% YoY and as always, it is key to watch if the CPI housing rent component starts rising.
In the Eurozone, conditions continue to improve and we forecast GDP growth at 1.9% HoH SAAR for the next two quarters. The weakness of the EUR and some improvement in credit conditions should continue to help significantly, but we are beginning to see some softening in exports, likely due to China and emerging markets. Lower oil prices will keep inflation slightly negative for the next many months, but core inflation, which never went negative, should continue near 1% YoY. As the ECB pointed out recently, 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 in many countries. We do keep in mind, however, that underneath the surface, the entire system remains quite fragile. We still believe that Greece will avoid leaving the Eurozone, although it is clearly a tail risk, as execution of its debt program will be difficult. 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.
China’s economy 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 6.4% HoH SAAR growth in the next two quarters, which is moderately below 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 are declining, so construction will likely subtract from the economy this year, but housing sales have greatly firmed. Top tier cities’ property prices are quite firm, but middle to lower tier cities’ prices remain quite weak due to large oversupply. Interestingly, auto sales have softened recently, which is an important sign of slowing consumption, so we will have to monitor such carefully.
The government is acting rapidly to counter the deceleration in certain parts of the economy. 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 continued reasonably stable in the past quarter, although Brazil is badly struggling. A strong USD and softness in commodity prices have, however, been 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.