Morningstar's "Perspectives" series features investment insights from third-party contributors. Here, Alan Higgins, UK CIO at Coutts, gives his outlook for the economy and stock market.
Last week – in the face of a sell-off in equities and mounting volatility – we expressed our continuing optimism in global economic recovery. Since then, economic data has largely justified our sanguine view.
Fears of a slowdown and China and recession in Europe – big contributors to angst about global growth – have abated. Although annual growth in China’s gross domestic product (GDP) slowed to 7.3% in the third quarter, this was better than the 7.2% pace expected. HSBC’s initial “flash” estimate of China’s purchasing manager’s index (PMI) of manufacturing activity also rose more than expected to 50.4 - above 50 signals expansion. This is evidence that the government’s recent stimulus measures are working.
Flash estimates of Europe’s manufacturing and services PMIs were also better than expected, suggesting continued expansion. The manufacturing PMI came to 50.7 from 50.3, confounding consensus expectations for a dip below 50, while the services PMI was steady at 52.2.
Another source of anxiety for global investors has been the withdrawal of US quantitative easing (QE, or bond purchases), which has been helping prime the pumps of global liquidity for some time. There was also good news on the QE front over the past week, as reports emerged that the European Central Bank (ECB) was looking at significantly expanding its bond-buying programme to include corporate bonds.
Investors were comforted by hopes for the ECB and Bank of Japan to take on the role of global liquidity providers, filling the void left by the withdrawal of US QE.
The recovery in sentiment has been rapid and pronounced. The MSCI World Index of developed equity markets had lost all of its gains for the year in the sell-off, but now it’s up over 3% year to date. Safe-haven government bond yields are still extremely low – a measure of how risk-averse investors remain. But 10-year UK gilt and US Treasury yields didn’t stay in panic mode – having dropped briefly below 2% – for very long and are now hovering near 2.2%.
Volatility Reinforces Equity Preference
Recent volatility has made equities more attractive relative to bonds. While bond yields are off their extreme lows, the future long-term return potential of government and investment-grade bonds remains at historically low levels. And they look especially limited compared to equities.
The main risk to our positive view on equities would be a global or a US recession, resulting in a significant fall in earnings. But we don’t see this as a significant risk. The Anglo-Saxon economies – the US, UK and Australia – remain robust, while QE hopes should help support Japan and Europe. While Europe is weak, we don’t expect a recession and see lower oil prices and a weaker euro providing some stimulus alongside ECB action.
Disclaimer
The views contained herein are those of the author(s) and not necessarily those of Morningstar. If you are interested in Morningstar featuring your content on our website, please email submissions to UKEditorial@morningstar.com.
