WHERE IS THE BOOM AMONGST THE GLOOM?
Author: Jacobus Lacock
The 2016 “Happy New Year” greetings faded swiftly this year as the collapse of equity markets globally hints at a difficult year ahead for investors. US equity investors experienced the worst first week in a year ever as the S&P500 fell 6%. Fears of an imminent economic crisis in China, credit defaults, oil collapse, US recession and geopolitical shocks have gripped the market.
Even billionaire investor George Soros recently warned; "I would say it amounts to a crisis. When I look at the financial markets there is a serious challenge which reminds me of the crisis we had in 2008." He was talking about China’s economic adjustment challenge and financial market concerns.
One has to view Soros’ comment in the context of another of his famous quotes; “The financial markets generally are unpredictable. So that one has to have different scenarios… The idea that you can actually predict what’s going to happen contradicts my way of looking at the market.” Mr Soros highlighted the magnitude of challenges that China faces, however how and when China will overcome these challenges is largely unpredictable.
Our own view is that the number of risk factors and uncertainty has increased, and to reflect this investors require a higher risk premium, which is reflected by lower asset prices. How big should the risk premium be? Current market volatility suggests that market participants are still figuring that out. When we analyse these risk factors against asset prices and market volatility we conclude that too much gloom has been priced in for 2016. We see a low risk of the major economies; namely US, Europe, China & Japan, going into recession. Together they make up more than 60% of world GDP and contribute around the same amount of world growth. These economies will remain strong enough to support global growth due to the following factors;
- the major central banks remain accommodative with easy monetary policy;
- the scope for fiscal support from governments in major economic regions has increased; and
- lower commodity prices benefit global consumers and reduce the cost of growth.
Outside of the major economies we are in a crisis led by the fall in commodity prices, currencies and credit quality. I have elaborated on this in a piece I did in July called What’s up with commodities. In short, demand supply dynamics in commodity markets will only rebalance once producers cut or exit production which implies job losses, defaults and economic reforms. The self-reinforcing cycle of lower commodity prices, weaker growth, weaker currencies and higher interest rates in commodity-producing countries will remain a challenge for commodity-producing countries and sectors and a source of bouts of risk aversion.
Before we review the major risk factors, we set out our outlook for South Africa and economic growth forecasts for 2016 relative to consensus. On aggregate we remain more optimistic than consensus on developed markets growth and less optimistic than consensus on emerging markets growth. China is the exception where we believe growth will be marginally better than forecasted by the market.
Happy New Year!
Download and read the full Global Outlook for 2016 here.
Download and read the 2016 Global Risks here.