Neil Dwane says investors should expect growth to remain slow, low and fragile, and expect volatility to continue buffeting the markets. To make the most of this environment, take an active approach to stock selection and asset allocation.
Asset markets endured a great deal of sound and fury during the first quarter, as fears surrounding China, oil, negative interest-rate policies (NIRP) and politics all served to undermine investor confidence. That, in turn, led to a severe rout in the first half of the first quarter, which was followed by a strong rally that nearly moved markets back to starting levels.
So where are we now and how might the second quarter play out? Amusingly, despite all this market volatility, global economic growth has remained as dull as we expected it to be, with our financial repression thesis in full effect.
The United States
Notably, US economic data remain lacklustre and unconvincing, despite the fact that during the same time last year, economic performance was weak due to a polar vortex. Industrial production has stalled, employment is stable and wage data are flat, so there are few real drivers for the US economy.
As a result, growth expectations have progressively fallen toward a sub-2-per-cent pace, which has allowed the US Federal Reserve (Fed) to sound more dovish once again. In turn, the dollar has weakened somewhat, which boosts the prospects for US earnings and emerging economies.
We expect more of the same in the second quarter, although it seems prudent to expect one hike in interest rates before the summer: The Fed does not want to implement a policy change during the serious election campaigning later this year.
Fears of a massive renminbi devaluation, a recessionary economy and a credit bubble have ameliorated somewhat as China’s government has agreed on – and started to execute – its next Five-Year Plan. Beijing knows it needs economic growth while it transforms from exports and manufacturing toward consumption and services, and we expect China’s economy to become more stable this year. This transformation will take time and will structurally alter the level of demand for many commodities where excess supply capacity has been created; as a result, we would still avoid many commodities-driven emerging-market economies.
The European Union (EU) has quietly had yet another good quarter – possibly outgrowing the US – as austerity benefits continue to pay off and as the European Central Bank finds increasingly innovative initiatives to support and invigorate both the weak EU banking system and the underlying demand for credit in the real economy.
While the migration crisis still festers – including painful outbursts of anti-immigration sentiment in Brussels, home of the EU’s headquarters – another significant political threat will emerge in the second quarter: the Brexit referendum in late June. This vote will have important consequences for Europe if the UK votes to leave the EU, which we believe is unlikely; Brexit would add volatility to pound sterling and euro assets, and challenge politicians across the continent.
Interestingly, the European identity crisis is still having effects on national politics around the region; with Ireland and Spain having both experienced incomplete election results recently, we expect European politics to remain a headline-grabber for the rest of the year.
Other economies have continued the trends they followed in 2015. Brazil remains in a recession, and it faces a serious political crisis with the impending impeachment of its current president. South Africa, too, is facing its own recession and another African National Congress leadership crisis. On a positive note, Indonesia is seeing some improving investment under the leadership of Joko “Jokowi” Widodo. In India, Prime Minister Narendra Modi is getting inflation under control and starting to implement reforms; so far, he has been hampered only by abnormal monsoon seasons, caused by El Niño. Japan, on the other hand, has reacted badly to the implementation of NIRP, with an ageing population that currently fears inflation more than getting a return on its investments.
We continue to expect growth globally to remain slow, low and fragile, and we expect many asset markets will be buffeted by volatility – both from within, in terms of the economic and corporate sectors, and from without, especially from the political sphere. On a global scale, investors still have opportunities to find attractive income and capital appreciation potential, but they must be prepared to be active in their stock selection and asset allocation.
Neil Dwane journeys beyond the official news releases to find a capitalist country full of enterprise, where countless citizens are pursuing the American dream in Chinese characters.
While many investors fixate on China's economic data – its exports, infrastructure investments and capital account outflows – we at Allianz Global Investors have long understood that one never gets a well-rounded picture from balance sheets and official news releases alone.
That is precisely why we form our global view using local investment professionals who conduct their own research, and it is why our unique GrassrootsSM Research division has built a network of on-the-ground sources around the world. True insights can come from anywhere, and with a country as dynamic and complex as China, the real story is evident in its residents' day-to-day lives.
Just visit two of the country's most popular attractions and one will find a capitalist country full of endeavour and enterprise – one with billions of inhabitants pursuing the "American dream" with Chinese characters.
The Pandas in Chengdu
On a recent trip to Sichuan to see China's national treasure – the panda – I saw clear evidence that China is no longer an "emerging" country reliant on cheap exports and "roads to nowhere":
- Chengdu, the centre for pandas, has a population of 15 million and has expanded to meet the needs of its population in every direction, building five ring roads and two airports for international and domestic traffic – very much a modern metropolis.
- The push-bikes are gone and almost everyone now drives a car – most of which are European and Japanese, and cost twice the amount of a local or locally assembled car.
- Chengdu has become a centre for domestic tourism, with residents flocking to see the rare panda and breathe the clean air of the Taoist mountains.
- The expansion continues in nearby Dujiangyan, which is building a USD 9 billion hotel and entertainment project that will significantly increase the number of visitors to the region.
The Shift Away from Agriculture
On the 250-kilometer road to the great Buddha at Leshan, built between 713AD and 803AD, one sees agriculture projects that are small in scale, even though many hillsides are packed with tea plantations reaching up to the top. As the urbanization of China continues, with many agricultural workers migrating to the cities during the winter for extra wages, it is clear that China will need to create more efficiencies and economies of scale in its agricultural sector, as has been done in the US and Europe, so that the country can remain broadly self-sufficient. Yet this process will take time, and the appeal of farming is waning: The younger generation does not want to follow their parents into such a difficult lifestyle, and mobile technology is increasing their awareness of the many opportunities available to them inside and outside of China.
The Warriors of Xian
In Xian, once the capital of China and the home of the famous terracotta warriors, one finds another huge city, bigger than London, with a population of more than 10 million. The city is a hub for both medical and aerospace research and development, yet it also has serious traffic issues: Within the 10 miles of ancient city walls, built in the 16th century, the roads are not yet big enough to serve the sheer number of cars. Yet despite Chengdu and Xian being called "Tier 2" cities by the Chinese government, they have a modern look and feel – a mix of old neighborhoods, new developments and American-style freeways.
The Buzzing Cities
These less-famous Chinese cities have a buzz and a fast pace of life like any other city in China, powered by soaring populations and growing wealth. Credit the work ethic of China's people, which remains very strong: For the younger generations, a good education is crucial; their parents, meanwhile, still want to save, provide for their children and buy homes. Most everyone I met seemed fired up by the "American dream" – eager to work hard, get their lucky breaks and get rich.
As China rebalances its economy to find new growth engines, there are still many domestic opportunities for its people to become successful as markets grow and economic maturity spreads wealth. Of course, capitalizing on those opportunities requires the same blend of talent, luck and contacts needed elsewhere. But China's people understand that with success comes the ability to buy options, just as in the West, which is why they are so energized and determined to succeed – and why each of the country's 37 provinces has market potential similar to the UK's. Although still ruled by the Communist party and still classified as an emerging-market nation, in daily life, China feels like a capitalist country – busy, bustling and loud.