Both the US and UK continue to battle inflation and while the rate at which prices rise in the US may have slowed, at 6% (at the time of writing), it’s still substantially higher than the US Federal Reserve’s target rate of 2%. Recent revisions to UK GDP showed they missed slipping into a recession at the end of last year. However, indicators point to an economic slowdown in both the US and UK.
Which raises the question, is this a global phenomenon? While the world’s economy is still very interconnected, we’re seeing a desynchronization in the business cycles of developed and emerging markets.
Business cycles are characterized by periods of acceleration (expansion and peak) followed by periods of slowdown (contraction and trough) – they give an indication of the overall state of an economy at any given time. A country’s GDP, level of unemployment and consumer spending can all be used to determine the current stage of an economy.
As developed markets (DM) – most notably the US – continue to battle inflation and economic impact of much tighter financial conditions, the story isn’t the same in emerging markets (EM).
In 2022, we’d already witnessed a divergence in central bank policy between some EM and DM economies with the People’s Bank of China adopting a much looser financial policy in comparison to its US counterpart.
And more recently, the reopening of China (following the abandonment of its strict zero-Covid policy) has brought a much more positive outlook, not just to China but to the wider region. Recent Purchasing Managers’ Index (PMI) data indicates EM and Asian economies are leading the rest of the world in terms of their outlook for growth.
This isn’t the first time we’ve witnessed a divergence between DM and EM. Back in 2001/2002 (a period that bears some resemblance to now), EM equities outperformed US equities, despite a backdrop of weak global growth. In general, emerging markets outperform developing markets in periods of stagflation (low growth and inflation) as well as during periods of reflation (accelerated growth and inflation) so we would expect EM equities to provide a positive outcome in either scenario.
Diversification isn’t just about holding a mix of different types of assets, it’s also about ensuring diversified exposure to different regions.
As the outlook for the US economy remains challenging and indicators point to a probable US recession, we’ve reduced exposure in portfolios to US equities, choosing instead to increase the allocation to EM equities.
Coutts’ clients can find out more about what’s happening in the investment markets and how it impacts their investments by speaking to their private banker.
Past performance should not be taken as a guide to future performance. The value of investments, and the income from them, can fall as well as rise and you may not get back what you put in. You should continue to hold cash for your short-term needs.