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Global Market Strategy Q2 2010: Overview
By Arnab Das
Editor’s Note: The following research is exclusively available to RGE Strategy level clients. If you’re having trouble accessing this piece or have questions about your RGE account, contact the appropriate RGE sales office.
Following RGE’s Q2 Global Outlook Update, we offer our Q2 Global Market Strategy. This collection of pieces implements our macro views across major asset classes and focuses on asset allocation and positioning within fixed income, emerging markets, global equities, and financials. Briefly, this compilation comprises:
- An extensive presentation by Arnab Das, managing director of market research & strategy, encapsulating the macro themes that RGE sees dominating asset markets in 2010 and beyond.
- Views on bond markets, by Arun Motianey, director of fixed income strategy, focusing on U.S. and European bonds and the credit market implications of a potential rate-hike in the United States.
- Views and recommendations on global equity markets, by Gina Sanchez, our director of equity and asset allocation strategy.
- An update of RGE's views on emerging market assets, focusing on currencies and debt, by Natalia Gurushina, director of EM strategy.
- An assessment of the global banking sector, examining sources of earnings potential in the context of historical data and consensus expectations, the relative value of financial sector equities, and the potential implications of financial regulation, by Jennifer Kapila, our strategy analyst.
Each of these pieces of analysis is rooted in RGE's views on the trajectory of the global economy. It is therefore worth taking note of some of the assumptions underpinning our recommendations.
Global Macro: A year of two halves and a multi-speed global recovery
First, we anticipate that the United States and the other major economies in the developed world will post anemic growth over the course of 2010, emerging from the “Great Recession” in a protracted, U-shaped recovery. Some major economies may fare worse. Japan and some parts of Europe, for instance, are at greater risk of flat-lining into an L-shaped recovery, or even double-dipping back into recession. Emerging markets, by contrast—and particularly those in East Asia—will bounce more quickly than the advanced economies, posting growth more in line with a V-shaped recovery.
RGE continues to expect a “year of two halves,” with fading government support translating into markedly weaker growth in H2 in the major high-income countries. In the United States, persistent high unemployment seems likely to limit personal consumption growth, and thus economic recovery, after base effects fade and fiscal incentives that front-loaded demand expire. The U.S. will lead Japan and Europe, however, due to a more flexible economy and greater fiscal capacity, given the dollar’s standing as the global reserve currency.
Continuing fiscal retrenchment in the Eurozone, and particularly across southern Europe, given lingering sovereign debt crises, is likely to lead to sluggish European growth as well. Greece represents the most urgent of these crises—should the situation there unravel in a disorderly manner, Europe's economic woes could be sharply exacerbated in the near-term. We do, however, see a North-South divide within Europe, and we anticipate that both competitiveness and the current account deficit in Germany will improve over the second half of the year.
Emerging Market (EM) economies in Asia and Latin America will fare far better, largely because they do not face the balance sheet constraints that pose such strong headwinds to a robust recovery in the major high-income countries. If anything, stimulus programs in some countries have been too strong and successful, with Brazil and India growing above potential and so requiring monetary tightening; and credit booming in China, raising the specter of inflation despite the addition to overcapacity resulting from a 25% of GDP stimulus, the world’s largest, in 2009. EEMEA is the exception to this bullish EM story, largely because much of this emerging region participated in the global credit boom and now requires a significant balance sheet adjustment to cope with the reduce availability and increased cost of credit. Russia will post a significantly lower rate of growth than it did during the boom years because the ongoing credit crunch will partly offset the benefits of the renewed commodity export price boom.
Global Markets: Divergence trades galore defined by balance sheet conditions
Given our macro assumptions, the general asset market themes that have dominated for the past six months should continue through H1 2010, very much in line with projections we first made in October 2009. The USD should remain strong against other advanced economy currencies—the EUR and the GBP in particular. As the U.S. yield curve continues to steepen through H1, portfolio shifts out of bonds and into riskier assets will continue in the United States.
The market seems to expect that the government support propping up recovery in the U.S. and elsewhere in H1 will pass the baton to the private sector, which will play a stronger role supporting economic growth and markets in H2. We disagree with this premise. In the U.S. and Western Europe, fiscal restraints and balance sheet consolidation are likely to ramp up in H2. As this happens, equities—which have already seen their rapid run-up taper off to a degree—will start to underperform.
Corporate bonds are likely to outperform equities for the year as a whole—and particularly high-grade corporates, which by and large have the benefit of lots of cash and strong balance sheets. As growth slows over the course of H2, it should weigh on earnings, which are unlikely to continue beating expectations through the end of the year.
The strength of EM economies in LatAm and Asia, in turn, is likely to mandate tighter monetary policies in EM economies. Currencies in many EM nations, particularly in East Asia, are likely to strengthen against the USD, and the potential for strong carry trade activity should continue throughout 2010. EM equities will underperform, however, as the withdrawal of policy responses starts to take effect.