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Global Markets Weekly - 13 July 2009

• We continue to expect a weak recovery - a view with which the IMF concurs.
  ‘The good news is that the forces pulling the economy down are decreasing in intensity,’ said the IMF’s chief economist last week. ‘The bad news is that the forces pulling the economy up are still weak. The balance is slowly shifting, and this leads us to predict that, while the world economy is still in recession, the recovery is coming. But it is likely to be a weak recovery.’ That is pretty much in line with our own macro-economic forecast. The IMF expects world output to grow by 2.5% in 2010, led by emerging economies, while developed economies grow by only 0.6%.
• China's huge stimulus is boosting the whole Asian region.
  On the good news front, China seems prepared to do whatever is required – including hosing the economy with credit – in order to generate growth of 8%. The June loan growth figures came in at a massive 1.5 trillion renminbi (Rmb), more than double the amount in May. That puts new loans for the first half of the year at Rmb7.3 trillion ($1.1 trillion), versus Rmb4.9 trillion for the whole of 2008. It’s no wonder the IMF has revised up its Chinese GDP forecast for 2009 and 2010 by 1%. The rest of the region also stands to benefit.
• The US outlook is improving, helped by demand for exports.
  In the US, surveys of service sector activity and new orders are fast approaching the 50 level, which is consistent with positive growth. Part of the demand is coming from overseas: the export orders index is up 20 points from last November’s 34.5. The employment index of the US services Purchasing Managers’ Index (PMI) rose to a nine-month high. If sustained, that would be consistent with non-farm payrolls falling by 300,000 a month. Though still poor, that is less bad than the current three-month average of 436,000.
• The UK decided against expanding QE, amid rising expectations for growth and inflation.
  Unlike most sovereign bond yields, gilt yields rose last week in response to the Bank of England’s unexpected decision to cap its intervention in bond markets at £125 billion. This reflects the turnaround in the money supply, which is now growing, reflecting the impact of quantitative easing (QE). The Bank's decision will also have been influenced by the National Institute of Economic and Social Research's flash forecast of second-quarter GDP, which showed a much-reduced rate of contraction in the economy, and by investors' mounting concerns about inflation, reflected in the inflation swaps market.
• As risk appetite declined, defensive currencies benefited.
  The clear trend of falling commodity prices and a flight from riskier assets was evident in currency markets. The winners were defensive currencies, such as the Swiss franc, the US dollar and, for this cycle, the yen, against which the Australian dollar fell 7% last week. However, the euro’s losses were pegged back by an improvement in German industrial production and manufacturing orders, which rose for the third month running and are now up 8% from February's low.
• Euphoria is giving way to realism about the recovery, which looks set to be weak.
  We had been saying that, for markets, as with journeys, the phrase ‘to travel hopefully is a better thing than to arrive’ often applies. And here we are in the second half of the year, with the economic recovery looking on course to arrive as predicted. Yet markets, having come so far and so fast since March, are stumbling, caught by the swings of investor sentiment and the familiar cycle of overshoot followed by pull-back. We see this as a clear opportunity to invest gradually in markets where valuations offer the prospect of attractive longterm returns even in an environment of constrained growth.

Indices, Interest rates and Inflation

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