Over the past few months, there has been a double dip in commodities and bond yields, and the bull market in Chinese stocks came to an end, ushering in a bear market in emerging-markets equities and a meaningful correction in developed-markets stocks. Yet perhaps the most important development has been the collapse in confidence and conviction. The clear signal is that this is no market for heroes.
Weakness in China will weigh on global growth. We at J.P. Morgan Asset Management don’t think it will derail it, however. Dollar strength and oil weakness have wiped out a year of earnings growth from U.S. stocks, and Europe is prone to aftershocks as economic wounds lingering from the 2008–’09 financial crisis continue to heal. Nevertheless, domestic U.S. strength persists and warrants slow normalization of rates; sentiment in stock markets is weak, which presents a low hurdle for positive surprise; and Europe’s first true postcrisis test — Greece — caused barely a blip in the data.
So why the collapse in confidence and conviction? Simply put, growth is low by historical standards, policy is unusual, and after two decades of globalization, we are in a new world that challenges our assumptions about the plumbing of the global economy.
Even after seven years of expansion, we view the U.S. economy as only in the middle of the cycle, which is why we see a low risk of recession. And for all the concern over developed-markets policy divergence and emerging-markets economic weakness, our research on the synchronization of business cycles suggests that the apparently dislocated world we see today is by no means unusual.
A common thread running through the year is the low level of global growth. To the optimists, a sluggish recovery has more scope to persist. To the pessimists, we’re one mishap away from a slump. Early-year themes of a strong dollar and weak oil have largely played out, and the collateral damage on S&P earnings growth will heal. By contrast, China’s challenges are persistent and continue to weigh on emerging-markets and commodity producers. We expect this weakness to drag on global growth into next year. More profound, however, is the growing chasm in growth outlook this creates between the consumption-led developed world and export-dependent emerging economies.
China will continue to divide opinion. Whereas China has accounted for about one third of world nominal gross domestic product growth since the crisis, International Monetary Fund projections have this proportion falling to around one fifth in 2016. The U.S. and, increasingly, Europe drive global growth, and we remain optimistic that the domestic recoveries in both regions are robust. But emerging-markets weakness will constrain global growth rates, leading investors to prefer so-called carry-and-roll assets such as dividend-yielding stocks and credit over seeking capital growth alone.
The global growth gap manifests itself in divergent central bank policy. Despite holding rates steady at its September meeting, the U.S. Federal Reserve continues to signal the start of a rate-hiking cycle this year. By contrast, emerging-markets central banks are easing policy, and in Europe and Japan quantitative easing is in full swing. The implications of central bank bond demand and low inflation expectations appear fully reflected in sovereign yield curves. So interest rates all along the curve should grind higher when the Fed raises rates.
We remain cautiously optimistic on risk assets, with a preference for developed markets. Questions over growth and policy lead us to moderate portfolio risk, however. Markets that look attractive include U.S., euro zone and Japanese equities; U.S. high-yield credit; Australian bonds; and the U.S. dollar. Meanwhile, investors should be cautious of holding cash, emerging-markets equities, Canadian bonds and the euro.
Balanced, gradual healing of developed economies will more than offset weakness across emerging markets, leading to a steady maturing of the midcycle phase in which the U.S. economy sits.
John Bilton is head of global multiasset strategy at J.P. Morgan Asset Management in London.
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