There has been a run of stronger data from the UK economy over recent weeks. This has encouraged a great deal of media commentary, heralding the arrival of a more sustained expansion, and seemingly raising expectations of UK GDP growth across the board – including at the Bank of England.
Just a few months after fears of a ‘triple-dip’ were dominating forecasts, it might be right to be sceptical about such a turnaround. But in the context of the rest of the global growth picture, the recent UK data looks consistent with a broader improvement having been underway through the middle months of this year.
The last time the Global PMIs (shown below) were all above 50 for the major regions was June 2011.
Hindsight affords us the luxury of observing that the 2011 synchronised expansion was not to last (in the PMIs and in market beliefs/pricing) as ‘events’ took over: Euro Area structural issues (sovereign debt, etc.), Middle East unrest, perceived increase in global recession risk, and further reaches into uncharted territory with regard to monetary policy actions, bringing with them varying bouts of relief and anxiety.
Ultimately, the macro data have continued to be fairly uneventful over this entire period, broadly describing a backdrop of mediocre growth with some weaker (Euro periphery) and some stronger economies (US). And all the while, the corporate sector has, by and large, continued to accrue more of the benefits of what growth there has been than the household sector. This is a critical point with regard both to the likelihood of inflation (low) and to the appeal of equities as an investment prospect (high).
The extent to which these observations are relevant to our global asset allocation decision today depends upon how this change in facts (better growth) is being reflected in a change in the price of assets.
In equity markets, the US has continued to outperform strongly, with the S&P gaining 30% over the period since June 2011. US corporate earnings have grown too, just not by that much. So our measure of the US EY has fallen from 9% to 6.5% over this period. Still an attractive prospective long-run return, to which we want to maintain a material exposure.
The market has shown less enthusiasm for ‘emerging market’ equity. Chinese equity prices have fallen by 24%, lifting the EY from 14% to 16% – as earnings have continued along a reasonably firm path; with increased doubts over the ‘quality’ of those earnings numbers perhaps adding a further risk premium. With that in mind, a more compelling EM example from our point of view is South Korea. The KOSPI index has fallen by 14% over the two years since mid-2011, with the journey to that loss being more volatile than many markets. Against this backdrop, Korean earnings growth has proceeded nicely, pushing the market’s EY from an attractive 11.5% in June 2011 to 12% today. In an environment of global economic expansion and supportive interest rate policy, a 12% long-run real return is clearly very appealing and, in our view, unlikely to persist before being eroded by price gains (of potentially quite a material size).
Perhaps the most interesting comparison between June 2011 and today is in the behaviour of bond markets. To be sure, the level of yields (when considering the US 30 year Treasury) is lower today than it was two years ago, at 3.7% now compared with 4.25% then. But there has been a significant shift in the market’s response to firmer global economic data this time around, with bonds selling off aggressively over recent months (shown on the chart as a blue dotted line). Indeed, the extent of the bond selloff has been comparable to that seen in the bond bear markets of 1994 and 2003. (Economists at the New York Federal Reserve have written a blog on this)
As we have stated in our previous posts, we believe that the backdrop for growth and inflation does little to justify a major shift to higher yields (in the developed markets in particular), while from an overall asset class stance, equities continue to offer superior prospective returns than most bonds. However with recent moves in markets, the opportunity to improve the potential diversification available for a multi asset portoflio also appears compelling.