Please find below the notes from GAM Investments’ Weekly Investment Meeting on 4 July 2018 – this week’s speaker was Michael Biggs, who explained why he believes the outlook for risky assets remains promising and provided an update on emerging market fundamentals.
Macro overview and emerging markets
Based on macro fundamentals we believe the outlook for risky assets remains good. At the end of 2017 and into 2018 the Economic Surprise index moved positive. It then subsequently deteriorated into negative territory, largely driven by the euro area with added headwinds from the volatility spike in February, the Italian elections and ongoing trade war concerns. Meanwhile PMIs got to extremely high levels, before retrenching in the first quarter, and we have seen a renewed uptick in the latest month’s numbers.
The credit impulse has been positive in Europe. This is normally associated with above-trend growth, but there is nothing to explain why PMI readings were quite so high. The lending numbers out of Europe are still strong. May’s figure is consistent with a PMI of 54 to 55, which would indicate 1.5% to 2% growth; growth in Europe is above trend and positive for risky assets.
The debt to GDP ratio in Europe is also coming down. Global PMI and GDP growth tend to be well correlated over time. As a rule of thumb, global growth of 3% equates to 0% earnings growth in Europe, with global growth of 3.5% suggesting 5% growth in Europe and 4% global growth 10% in Europe. The ISM versus S&P500 correlation has been consistent, with sound equity returns. The relationship between equities and bonds indicates there is a good opportunity to look for investments.
The two major risks to this view are trade wars and rising inflation; we are only concerned about the former at present. The consistent theme looking at PMIs has been rising price pressure. The US/China tariffs situation has no real winner, but there should not be too big an impact on growth. Our view is that this will settle down but there is downside risk. However the underlying macro picture remains positive.
Emerging markets have seen a rebound. Credit growth has stabilised at 5% and started to pick up, and the macro fundamentals are exceptionally good. The credit impulse went from negative to neutral, then positive, as GDP growth increased from 3% to more than 4%. Credit growth is still low relative to history, and we believe it will be hard for it to fall in a sustained fashion. While it rises, strong EM growth should support asset prices.
So if the fundamentals are strong, why have EM local currency bonds1 just endured their second worst quarter ever? In our view this is a USD versus EM FX story. We remain bullish about EM fundamentals – we just need some USD stability. If Europe performs in line with expectations that should be enough to give us this stability and change the EM narrative, triggering the rally we think is deserved.
However, we are maintaining a cautious stance in respect of Turkey. The country is faced with the choice of weaker growth or a widening current account deficit. If growth slows too much, a surge in bad debts could cause the banks to get into trouble. If they do, the current account might be difficult to finance, even if it has narrowed. Turkish corporates have taken on a lot of FX debt and as the currency weakens have had to restructure this debt. We are minded to retain this underweight, and being out of Turkey while this happens could be a source of positive performance.
1As measured by the JP Morgan GBI EM Global Diversified index, which was launched on 31.12.2002.
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The information in this document is given for information purposes only and does not qualify as investment advice. Opinions and assessments contained in this document may change and reflect the point of view of GAM in the current economic environment. No liability shall be accepted for the accuracy and completeness of the information. Past performance is no indicator for the current or future development.