Global Economic Recovery, Political Risk and Commodities
Global Economic Recovery, Political Risk and Commodities by Didier Saint-Georges, Managing Director and Member of the Investment Committee, Carmignac
A global economic recovery is underway. Growth has picked up across global markets for about a year, although during that same period markets have also had to contend with bouts of short-term volatility, with political risk driving much of that volatility. The Macron victory in the French presidential election, who campaigned on a pro-European platform, should now drastically diminish political risk on that continent and allow investors to focus on its economic fundamentals instead. As political risk dissipates, eyes are now also on central banks in the US and in Europe and on what they will do to navigate their economies through the different cycles of the recovery. Deflation is no longer the most potent threat facing the global economy. Instead, inflation is likely to take center stage and keep policymakers on their toes in the near future.
The cycle should become more than ever the key feature to assess. Financial markets are currently experiencing a synchronized growth, favourable for risky assets. Europe and EM are reaping the benefits of an economic upturn with a delay, whereas the US economy is more exposed to the risk of a deceleration in growth momentum, partly induced by political noise.
Emerging markets, which are export-dominant economies, are best positioned to keep benefiting from a recovery in the global economy. Their economic fundamentals, too, are improving for emerging markets, making them an appealing investment destination. In addition, corporate earnings have historically moved in lockstep with international trade, so it is reasonable to expect a growth in corporate earnings as international trade continues to increase.
In Latin America, where many structural economic changes are underway in countries like Brazil, Argentinaand Colombia, and after a lackluster growth trend during recent periods, the conditions are set to take advantage of this global positive cycle. However, investors have to keep several risks in mind. One of the risks could come from Trump administration’s protectionist agenda that could still directly impact economies like Mexico, which are highly dependent on US trade. Another risk could come from China, which has been a major source of foreign direct investment for Latin American countries like Peru. Indeed, the ongoing pressure of capital outflows, coupled with its rising debt to GDP ratio point to an unsteady growth basis for China. This is a threat to Latin American countries that must not be ignored.
On the commodity front, it has been a volatile start of the year. Short term oil price tends to be a function of market expectations, news flow, and variation in inventories. Over the short term, there is a strong case for oil prices rising through the next few months as US inventories draw down, OPEC discipline is maintained, and global demand continues to grow at a solid pace. However, over the longer term, the risk of US shale producers to start producing and exporting more, based on increasing capacity, could create a lingering risk of a disruption to the demand- supply balance.
Besides our positive short term view on oil, we are also positive on the near term outlook for mining and materials names, as long as the momentum in Chinese infrastructure spending continues. We favor base metals miners, while we also see some meaningful upside coming from metallurgical coal production for export to China, given the Chinese restriction on coal mining activity and environmental focus which looks set to provide a continuing boost for the seaborne coal market. In the long term, Chinese excess credit creation remains a risk, but for the time being, we do not see the credit impulse running into the ground.
Inventory build see oil prices sink again, as USD strength weighs on precious metals.
Chinese equities slump again, as mixed earnings see developed market equities trade choppy ranges.
FOMC in focus, more USD strength.
The global recovery rumbles onward, but the pace is slowing, weighing sentiment. Elevated volatility is a key feature across asset classes. The growth divergence between the US and other major economies will keep a firm bid under the US Dollar, with the FOMC meeting this week in focus. We expect the US is ready to raise rates in September, despite the market pricing in a November hike. Meanwhile, the Greek negotiations are extending, with logistical concerns likely to keep investors wary of being fully committed to European equities. With defensive assets beaten down recently, a surprise rebound is not to be ruled out.
Commodities
Inventory build see oil prices sink again, as USD strength weighs on precious metals. The U.S. Energy Information Administration reported another build in US oil stockpiles last week, prompting WTI crude prices to fall to the lowest level since end-March 2015. Meanwhile, the stronger USD is having an adverse affect across the commodities, space but precious metals, in particular, due to their strong monetary connection are being impacted more than others. However, tighter markets for platinum group metals should help stem the price declines. South Africa’s largest platinum miner Lonmin has announced closures to some of its mines, expecting to reduce production by 100,000 ounces of metal in 2015/16 – around 2% of total global mine production. The company indicated that at current price levels, the company is a loss making entity and cost minimization efforts are designed to turn the situation around.
Equities
Chinese equities slump again, as mixed earnings see developed market equities trade choppy ranges. Positive sentiment about Chinese intervention appeared to fade in early trading this week, with a sharp sell-off in Chinese equity benchmarks. Policymakers must tread a fine line between restoring confidence in local markets with domestic investors and convincing foreign investors of reforms that make markets more transparent and less susceptible to manipulation. We expect a relaxing of restrictions will be gradual but inevitably encourage more participation and greater stability. Q2 developed market earnings have been mixed, and combined with ongoing unease over Greek bailout discussions, European equity gains have faded over the past week. The discussions concerning the method of financing another Greek bailout are likely to be prolonged, and investors will remain on edge to see if depositors and/or bondholders need to take haircuts in the bailout process.
Currencies
FOMC in focus, more USD strength. We expect the Fed will continue to be balanced in its rhetoric and highlight the gains made in the jobs environment. There is an interesting divergence between market pricing and economic consensus on when the Fed will raise rate: the former is pricing a November hike, while economists expect a September tightening. Accordingly, we feel that as the market begins to price in a September hike, USD will benefit. The brief respite for commodity currencies is unlikely to last. With negative sentiment prevailing over fundamental conditions, we expect the recent rebound in commodity currencies is unlikely to last in the near-term. Weaker oil prices are weighing on CAD and NOK, while central bank rhetoric and negative China sentiment is pressuring AUD and NZD.
For more information contact:
ETF Securities Research team
ETF Securities (UK) Limited
T +44 (0) 207 448 4336
E info@etfsecurities.com
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