More Volatility Hits Markets as Growth Remains Dull

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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 lackluster 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.

Emerging markets
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.

Investment implications
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.

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About the Author
Neil Dwane is a portfolio manager, a managing director and the Global Strategist with Allianz Global Investors, which he joined in 2001. He coordinates and chairs the Global Policy Committee, which formulates the firm's house view. Mr. Dwane also leads our bi-annual Investment Forums and communicates our investment outlook.

Important Information
The material contains the current opinions of the author, which are subject to change without notice. Statements concerning financial market trends are based on current market conditions, which will fluctuate. References to specific securities and issuers are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Forecasts and estimates have certain inherent limitations, and are not intended to be relied upon as advice or interpreted as a recommendation.

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