China is experiencing something of a structural slowdown and that trend growth is declining.
However, we need to put this in the context of the rest of the world: China’s growth should still outpace other developing nations as well as the US and Europe. Recent reforms announced by the Chinese authorities should be supportive of sustaining future growth, although they will have limited near-term impact.
But…
There are, of course, risks. Europe remains vulnerable to any adverse shock, China is dealing with the consequences of a lending boom and central banks have to manage a transition away from extremely loose monetary policy at some point. Leverage remains high and therefore economic growth is reliant on asset prices remaining high.
All that being said, however, we think the world is less vulnerable than it has been for some years. Being an optimist we believe we are on the cusp of stronger cyclical growth in the global economy as many of the financial risks have diminished from where they were.
The main issue facing markets over the next two to three years is likely to be the prospect of a less accommodative monetary policy in the US and the impact of this on financial markets. So far we have already had the first ripples around the prospect of the Federal Reserve paring back its QE programme.
Attention will also shift to the prospect of interest rate hikes if growth is strong. Currently we expect the Fed to begin to lift short-term interest rates during the second quarter of 2015. With investors around the world having become comfortable with zero interest rates in the world’s largest economies, the eventual onset of a tightening cycle will be a prime focus for investors.
The outlook for Chinese growth will be a key factor in determining asset class returns, given its much increased importance to the global economy today. We expect trend growth to continue slowing in China, perhaps to 5% or 6% by the end of the decade. While this is slower than the previous 30 years, it would still represent strong growth by most countries’ standards – we have become used to the double digit GDP growth of the past few decades.
Periphery restructuring but economies still weak
Related to this is the composition of that growth is likely to shift and be less commodity intensive and more consumer driven. Although the risks have risen in recent years, we are not forecasting a financial crisis in China. On a medium- to long-term horizon we expect recent reform announcements to be supportive of growth.
The eurozone crisis, which has driven market volatility in recent years, is another big issue – on top of China and US/QE tapering – that will determine the direction of markets. The Outright Monetary Transactions’ programme introduced by the European Central Bank was successful in taking the pressure off bond markets.
However, there is far more optimism about the euro area and whether this improvement can be sustained over the next couple of years will have a strong bearing on investment returns, not just in Europe but globally. A fair amount of rebalancing has been achieved by the periphery countries in terms of unit labour costs or current account balances, but economic conditions remain depressed.
Things look stable currently but the risk of political crisis or a negative shock to growth could trigger renewed concerns.
