Peter Dorrian says it will pay to keep an eye on global uncertainties in coming months as investors look for a guide to the strength of the global economic recovery.
Domestic issues have absorbed much attention in Australia for the past couple of months – the election, falling interest rates and slowing growth, to name a few.
But now that the US and Europe are in full swing after their summer break, the focus of the financial markets is shifting back to global and fiscal policy issues.
As a result, market volatility is likely to continue, and investors could benefit from strategies that can weather the uncertain environment.
On the surface, things have been improving in many countries. Growth and unemployment numbers in the US have been slightly better, and the long recession in Europe appears to be ending.
Importantly, China’s economy, which slowed markedly during the first few months of the year, shows signs of stabilizing.
However, many of the issues that moved the markets in the first half of the year are resurfacing and are likely to influence equity and debt prices around the world in the months ahead.
US
Although the Federal Reserve’s intention to “taper” its asset purchases has preoccupied the markets since May, debates in the US Congress over funding the government and raising the debt ceiling have come to the fore recently. Two years ago, debate over the debt ceiling led to the loss of the US’s AAA rating from Standard & Poor’s and a flight to US Treasury bonds.
Europe
The European Central Bank’s pledge to be a lender of last resort has greatly reduced the risk of a downward spiral in Europe, but the region is still struggling to get back to potential growth rates. Without healthy growth, eurozone debt dynamics will continue to be a source of significant risk.
Japan
Prime Minister Abe’s aggressive expansionary fiscal and monetary policies are expected to support growth in Japan. However, any deviation from these policies could result in downside surprises in the markets.
China
While the economy appears to be stabilising, which is good news for the region, upcoming structural and policy decisions will affect the outlook for sustained growth in China.
Emerging markets
Investment outflows from emerging markets in the second quarter tightened financial conditions and raised questions about the growth outlook for emerging markets. High-quality emerging market countries, including China, Russia, Mexico and Brazil look likely to stabilise and grow the fastest, while lower-quality emerging market countries, such as India and Indonesia, will take some time to regain control of financial conditions and may even need assistance.
There are many positive signals in the global economy lately, but as these issues show, there are still many uncertainties. These evolving situations bear close watching as they will likely make or break the tentative global recovery, affecting the markets not only in the next few months but also in the long term.
In this environment of continuing uncertainty, and most likely continuing volatility in risk assets, an allocation to high-quality, lower duration fixed interest is a prudent strategy for investors. It is particularly well suited to those in retirement with limited ability to replace capital in the event of a downturn in equity markets.