The global slowdown appears to be abating, amid a pick-up in the hard data... Asian and emerging markets are pulling the global economy out of recession. Although the rate of improvement varies from country to country, there is now widespread survey evidence that the global slowdown is abating. Moreover, we are finally seeing an improvement in the hard data, with clear signs that global industrial production is stabilising after falling 13% between last September and the end of March.
...but the developed economies have been left with a vast burden of debt... The world economy is emerging from the crisis of the past 18 months profoundly changed. The major developed economies have been left with a lasting legacy of vast public sector debt issued to fund bailing out the financial system and stimulating stricken economies. The rise in debt is such that the developed world looks as if it has fought a war. And, in a way, it has, but it has been a policy war to avert a depression, rather than a military conflict. Emerging economies, such as China, India, Russia and Brazil, have come out of the crisis with enhanced roles in global policy-making, reflecting their increasing economic significance.
...so both governments and consumers will need to repair their balance sheets. After the war will come a period of austerity in developed economies for both public-sector and household finances. To get their finances in order, governments will need to cut spending and raise taxes. Meanwhile, households are set to be keener to save than in recent years. Fear of unemployment remains high, and the 25% fall in household net worth since mid-2007 (caused by falls in property and equity prices) should make households keen to rebuild their savings. This fiscal tightening and consumer de-leveraging, combined with muted growth in bank lending and greater regulation and state planning of the economy, is likely to hold back the pace of growth in the developed world in the years ahead.
The recovery will be led by Asia and emerging economies, whose finances are healthier. Hence, we expect Asia and emerging economies to be the main drivers of global recovery. Headwinds to growth are weaker in these economies: they have higher savings ratios, lower ratios of public-sector debt to GDP and greater state ability to influence credit creation. They are set to grow by some 5% in 2010, much faster than developed economies.
Quantitative easing has helped to restore investors' risk appetite... As they gain greater confidence in the economic outlook, particularly for many emerging economies, investors are seeing the return potential of riskier assets rather than just the risks involved – quantitative easing is doing its job. Against this backdrop, Asian equities, emerging markets and commodities could become the next bubble, fuelled by the heady combination of their superior growth potential and ultra-low global interest rates.
...which should benefit riskier assets, particularly in emerging markets and Asia. With the economy improving, riskier assets – such as equities, corporate bonds and commodities – appear to offer better long-term potential returns than government bonds. Given the structural headwinds facing developed economies, we see greater opportunities in emerging markets (especially Asia) and in thematic equity investment than in developed markets, such as the US and the UK. A global recovery led by Asian and emerging markets would support the prices of industrial metals and oil.
Credit markets still show signs of good value, as do inflation linked bonds. Within bonds, the best opportunities appear to remain in credit markets, where spreads have further scope to tighten, and in inflation-linked bonds, which offer insurance against longer-term inflation concerns. As evidence continues to mount that the economy is on a recovery path, investors should eventually look through the current deflationary pressure from excess capacity and start to worry about the inflationary risk of central bankers being too slow to reverse both low interest rates and quantitative easing.
