FYI | Jul 18 2012
By Andrew Nelson
With little to no growth on offer in the developed world, and with volatile markets jumping from risk-on to risk-off faster than rats up a drain pipe, the global economy is facing down an increasingly ugly scenario that is upsetting and confusing investors the world over. It’s not time to panic just yet and to be fair, things are hanging in about as well as you could rightfully expect given the circumstances, but something’s got to give sooner or later.
It’s like we’re back in 2008 all over again. All we seem to hear about is policymakers this and policymakers that, but in most cases the propeller heads that run and influence national, regional and global economies seem to be either unable or unwilling to make the right calls.
Given it is unlikely these folks will get their acts together anytime soon, and given responsible statesmanship has been put on the backburner in Europe and the US, analysts and economists from the BlackRock Investment Institute see increased odds of the global economy slipping into a stagnation scenario.
“The second half of 2012 will be dominated by three factors: policy, policy and policy,” said Ewen Cameron Watt, BlackRock Investment Institute’s chief investment strategist.
“European policymakers are working to end a three-year debt drama while trying to re-ignite growth. The US faces a weakening economy, elections and the expiration of tax benefits. China is trying to move toward a consumption economy while keeping up growth.”
The institute’s latest mid-year outlook report, titled Standing Still… But Still Standing, posits the most likely scenario is an increasing divergence between the world’s faster-growing emerging markets and the debt ridden developed world.
Under this scenario, emerging economies, including China, would lead the way in terms of growth, with the US economy struggling unsuccessfully to catch up and Europe to experience more recession followed by slow recovery in 2013.
The report notes that while divergence worked like a charm in the first part of the year, increasing economic headwinds now are pushing markets toward stagnation.
BlackRock has downgraded the probability of a divergence scenario to a likelihood of 35%-40%, while still believing emerging economies and assets will outperform.
“We still believe the US economy and assets will likely outperform Europe’s, and that emerging markets will support growth through monetary and fiscal policy,” said Peter Fisher, head of fixed income portfolio management at BlackRock.
However, the eurozone’s ongoing debt struggles, the unwillingness of markets to accept potential solutions, and slowing growth across the world have increased the odds of stagnation. The good news is that Fisher sees a growing realisation by European policymakers that the region’s banking system is an Achilles heel and there are increasing signs of a willingness to fix it.
US policymakers will soon be contending with how to handle automatic tax increases and spending cuts that could shave 4% off of GDP and fear of this looming "fiscal cliff" and general uncertainty about taxation already have CEOs delaying investment plans and hiring decisions.
According to the report, there is a positive side: the US housing market is starting to show some long overdue signs of life. Also helping are comparatively low energy costs, which are increasing the longer term chances of lower trade deficits, a more competitive manufacturing base and higher government revenues.
The Institute does see a very slim chance, in the neighbourhood of 5%-10%, of which the global economy is able to wean itself off of government stimulus and grows just above the long term trend. Such inflation would be marked by high commodity prices and monetary easing, thus driving up inflation around the world and effectively cutting the developed world's debt load.
There are a few scenarios that could play out, that could lead to BlackRock changing its view. Were the eurozone to prove itself able enough to fix its wobbly banking system and produce a realistic plan for closer fiscal union, or if the US economy firms up enough to avoid the looming fiscal cliff this would be a start.
The report’s view on China is a little more optimistic, noting some tentative signs Beijing’s recent easing and stimulus is having a positive effect. What BlackRock wants to see is receding inflation, which it notes should give policymakers the room to do a lot more.
So what does the BlackRock Investment Institute think you should do with your money?
First, make sure you are building a defensive portfolio that is focused on income. The report recommends using options to take advantage of the risk on/risk off market fluctuations. Limit your focus to either extremely short term, or five-year investment themes, while avoiding the dangerous three to six-month investment horizon.
BlackRock says to watch individual companies for opportunities and relative value trades. It likes direct investments into emerging markets rather than multinationals and also advises to invest in companies that enjoy strong cash flows and have a track record of increasing dividends.
In metals and materials, the report notes both oil and copper look good long term given looming supply gaps. Natural resources equities are preferred over physical materials because of valuations, while grains and agricultural equipment should begin to benefit from emerging market demand.
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