Recession Fears Overblown, Despite New Uncertainties
Britain has left; central banks get ready to act
Britain's vote to exit the European Union has introduced new uncertainties in the macro-economic environment.
It is a timely reminder that all is not well within the Developed Markets (DM) arena, with major central banks supposedly poised for emergency injections of USD liquidity had financial mayhem ensued.
Add to the mix a need to reassess central banks' monetary policy, with U.S. Federal Reserve shelving its hawkish stance, and growing market speculation that the dovish European Central Bank and Bank of Japan will have to embark on more extreme measures to support growth and prevent deflationary expectations from taking root, the pervading gloom in the global economy looks set to stay for a while longer.
No global or U.S. recession in 2016
Despite the plethora of gloomy news, global growth is still tipped to be close to the 3 per cent year-on-year handle. The U.S. economy is expected to grow around 2 per cent in 2016, not fantastic but not dire either. Europe and Japan may clock in a more tepid 1.6 per cent and 0.5 per cent respectively. China's growth has stabilized in recent quarters, although it remains to be seen if the policy-fuelled momentum can be sustained into the future.
Chart 1: G3 Composite PMI Generally Indicates Modest Expansion
Japan may perk up post meaningful structural reforms, possibly after the Upper House election this month.
Central banks poised to ease
The main difference that sets 2H2016 outlook apart from 2H2015 is that the Fed is no longer hawkish and global inflation remains lacklustre. The latter is both a reflection of the health of global demand, as well as the over-supply situation in crude oil prices, albeit with WTI up from sub-US$20 per barrel to around US$50 per barrel.
This allows major central banks the space to ease monetary policy in the interim, in light of growth headwinds.
Asia remains a silver lining
Indochina economies may still expand by 6-8 per cent this year, followed by Philippines (around 6 per cent), Indonesia (5.1 per cent) and Malaysia (4.4 per cent) with Singapore as the laggard (1.8 per cent).
Emerging Markets, especially Asia, may benefit from relatively higher yields and more stable macro-economic fundamentals. Asia should see growth stabilize in the second half of 2016, and remain a key growth region.
Brexit's damage should be assessed through the triple lens of economic, financial and political contagion. Contagion is what can turn a local shock into a global one.
Chart 2: Brexit will take 2 years to complete, at least
Our view is that Brexit's adverse economic impact will be largely contained within UK, and to some extent Europe. The UK accounts for 2.3 per cent of world GDP, financial and economic contagion risks remain small, but political contagion - the unity of the EU - is of a greater concern. If the UK fares well outside the EU, then other EU countries might be tempted to follow, although exit will be much more complicated for those that are members of the Eurozone.
We remain cognizant that markets will enter a risk-off phase as investors pull back to assess the implications of Brexit on the global world order.
This risk-off phase will in due course fade away as valuations and fundamentals become compelling. In the meantime, risks will be skewed towards the downside and we prefer to stay defensive.
In line with our more defensive stance, we are upgrading our DM Investment Grade bonds to neutral from an underweight position, while downgrading DM high yield bonds to underweight from neutral.
From our current neutral global equities position, we are turning underweight on global equities, largely due to the negative outlook for European equities, while raising cash to an overweight position as the uncertainty in markets play out.
European equities will be most adversely affected by the implications of Brexit, while U.S. equity markets would be more defensive given its economy's underlying resilience.
Within the context of a diversified multi-asset portfolio, investors with large overweight holdings in European equities should use short-term rallies to trim their positions. Investors low on European equity exposure may consider investing in Europe as the current risk-off sentiments may offer opportunities.
With major markets expected to turn substantially more turbulent in the short-term due to heightened risk aversion, we favour multi-asset solutions strategies as they seek to manage risks and/or exhibit low correlations with the broader markets. Exposure to these strategies should provide benefits of market participation in the event of a pick-up in risk sentiments (we expect macro fears to wane through time) while mitigating potential downside risks.
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